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House Financial Services Committee Hearing with Prudential Regulators

House Financial Services Committee

“Oversight of Prudential Regulators: Ensuring the Safety, Soundness and Accountability of Megabanks and Other Depository Institutions”

Thursday, May 16, 2019

Key Takeaways

  • Inter-affiliate Initial Margin Exemption: When asked for a status update on exempting inter-affiliate transactions from initial margin requirements, McWilliams stated that “we are working together on updating the rule and we expect to seek comment in the near future” and that “we are committed to proceeding.” Quarles added that existing frameworks “should give us comfort in reducing redundancies in the inter-affiliate margin rules.
  • Volcker Reform: When asked about the current status of Volcker Rule reform, Quarles said that they have received hundreds of comments, which the five relevant agencies have been reviewing with the expectation they will respond to them soon. He noted that on the covered funds issue, the Fed asked specific questions so there will be an initial proposal and additional comment period.
  • Leveraged Lending: Quarles said that their analysis of the collateralized loan obligations (CLOs) holding structure is that there is not a risk of a financially destabilizing run from those institutions, even if there is a significant repricing of the leverage loan assets that the CLOs hold. He added that a separate but important question is whether the repricing of those assets could have a magnifying effect on a business downturn, but he does not think that would turn into a financial stability problem. Otting explained that bank management and the Boards of banks should make their own decisions on leveraged lending, adding that the banks should have the people, risk management and policies in place to “play in that space.” He added that he does not have concern about the banks they regulate, but that there may be “indirect transmission of the product,” so he has asked banks to look at their “food chain” and “who they are doing business with.”
  • G-SIB Surcharge: When asked about the global systemically important bank (G-SIB) surcharge and why it is appropriate for U.S. regulators to exceed standards set by the Basel Committee and impose more stringent capital and liquidity requirements on U.S. firms, Quarles said it is something that should be considered, particularly in the context of capital requirements not yet implemented domestically that could significantly increase capital levels, adding that as they think about how to calibrate various elements of the system, they need to think about it holistically.

Witnesses

Opening Statements

Chairwoman Maxine Waters (D-Calif.), House Financial Services Committee

In her opening statement, Waters expressed concern that fines levied against megabanks have amounted to “the cost of doing business” and have not led to changed behavior, noting the high profits of such institutions. Waters said she also has concerns about proposals to weaken capital standards and stress testing requirements for the largest financial institutions, saying that Congress is paying “careful attention” and will not tolerate actions that threaten the stability of the financial system. Waters noted that in the wake of passage of S. 2155, bank consolidation has accelerated, and that mergers should not be “rubber stamped,” but should provide a clear public benefit for the communities they serve.

Ranking Member Patrick McHenry (R-N.C.), House Financial Services Committee

In his opening statement, McHenry said that Dodd Frank resulted in more than 400 new regulations and 28,000 new restrictions, calling it a “massive undertaking” that has resulted in increased costs for financial institutions and “headaches” for consumers. McHenry said that the passage of the bipartisan S. 2155 balanced the need for financial stability and consumer protection with regulatory rightsizing, asking the regulators to “swiftly” implement provisions of the law, particularly the Volcker Rule, community bank capital simplification, tailoring for banks with more than $50 billion in assets, and improvements to the supplemental leverage ratio (SLR) for custody banks, among others. McHenry also said it is important to modernize the Community Reinvestment Act (CRA) and prioritize innovation in financial technology (fintech).

Rep. Gregory Meeks (D-N.Y.)
In his opening statement, Meeks expressed concern about the current expected credit loss (CECL) standard, calling on the regulators to seek to confirm and quantify the expected impact on community banks, minority banks, and access to credit for the underbanked before implementation. Meeks also expressed concern about the increasing disappearance of minority banks, leveraged lending, and CRA modernization.

Rep. Blaine Luetkemeyer (R-Mo.)
In his opening statement, Luetkemeyer said there needs to be cooperation between Congress and regulators, stressing the importance of implementing S. 2155 “without delay,” particularly tailoring for community banks, the community bank capital requirements, and SLR for custody banks. He expressed concern about the CECL standard and encouraged the regulators to delay implementation until the consequences are studied.

Testimony

The Honorable Rodney Hood, Chairman, National Credit Union Administration

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.

The Honorable Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation

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 regulatory agencies are working toward revisions to the rule to “provide more clarity, certainty, and objectivity to market participants.”

The Honorable Joseph Otting, Comptroller, Office of the Comptroller of the Currency

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. He spoke on the OCC’s diversity efforts, stressing that they are working to enhance diversity at all of their institutions through recruiting efforts, such as minority student organizations, to ensure they have diverse applicant pools. He continued that they have paid internships for minorities at the college level and will this year be extending that to the high school level so students can learn about financial literacy.

The Honorable Randal Quarles, Vice Chairman of 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.

Q&A

Bank Merger

Several Members asked about the pending BB&T and SunTrust merger, to which Quarles explained that there has been an active process of seeking public input through hearings and receiving comments and that they are staying within the congressional framework and timeframe they are subject to.

Transition from LIBOR to SOFR

In response to a question from McHenry on whether the transition from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) is concerning, Quarles replied with yes, which is why the Fed started “catalyzing” the public response to the transition years ago.

Executive Compensation

Rep. Nydia Velazquez (D-N.Y.) asked if the agencies have moved forward with executive compensation rules per Section 956 of Dodd-Frank. Otting replied that the OCC has drafted a rule and shared it with the Securities and Exchange Commission (SEC), and that once both agencies sign off on the draft it will be shared with the other regulatory agencies, adding that he hopes it can be released sometime this year.

CRA

Members on both sides of the aisle stressed the importance of modernizing the CRA. Otting noted that the rule is “highly complex” but that the agencies are working together on it the regulators agreed it should be a joint rulemaking. He continued that during their review they plan to identify all qualifiers for CRA going forward, and Quarles added that a theme he has heard from public comments is expanding the categories for investments that qualify for CRA.

Status of Pending Regulations

In response to Members on both sides of aisle, the regulators repeatedly stated that most of the remaining regulations should be out by the end of the third quarter, with all of them being released by the end of the year.

Rep. Steve Stivers (R-Ohio) asked if the Fed is considering incorporating an inflation adjustment to the tailoring provisions from S. 2155, to which Quarles replied that they have received “very reasonable” comments suggesting that and that they are taking it under consideration. Stivers then asked when to expect clarity on resolution requirements for banks that fall between $100-250 billion in assets, and McWilliams replied that they are “well under way in the process” and to expect them “soon.”

Volcker Rule

Rep. Ann Wagner (R-Mo.) asked about the current status of Volcker Rule reform. Quarles said that they have received hundreds of comments, which the five relevant agencies have been reviewing with the expectation they will respond to them soon. He noted that on the covered funds issue, the Fed asked specific questions so there will be an initial proposal and additional comment period.

Rep. Carolyn Maloney (D-N.Y.) asked if the regulators would commit to disclosing aggregated trading data to the public before finalizing changes to Volcker. Quarles called it a “reasonable request” and said they are looking into how to aggregate the supervisory data in a way that does not disclose the underlying confidential information, adding that he expects to complete the next step in the Volcker Rule process in the next 60-90 days.

Rep. Joyce Beatty (D-Ohio) discussed the relationship between venture capital and geographical diversity and asked during their changes to the Volcker Rule, if the regulators expect to exempt venture capital from the definition of covered funds as it applies to the Volcker Rule, and whether this could help to spread venture capital investment “more evenly” across the country. Quarles replied that they received “a lot” of comments on the treatment of venture capital under the Volcker Rule and covered funds provisions and that they are “actively considering them,” though they have not come to a final conclusion on how to address it. Otting voiced his support for the idea.

CECL

Members on both sides of the aisle voiced their concern about CECL, especially its impact on small banks and communities of low and moderate income. McWilliams stated that this is the first thing she hears about from community bankers and explained that “our hands are somewhat tied” but that the FDIC will do what they can to ease the implementation burden on the banks. She added that she is hoping that through the phase out and phase in period the industry can get information from the first groups of banks complying with the new rule. Quarles noted that if there are consequences during the phase in period, they will have tools to respond on the capital side. Hood noted that assistance is needed from the Financial Accounting Standards Board (FASB) to address issues with the rule, but that he is confident his institutions will be exempted from many of the “complex” forecasting required.

Inter-affiliate Initial Margin

Rep. Frank Lucas (R-Okla.) stated that the regulators before him are the only G20 regulators that still require initial margin for inter-affiliate transactions and asked for a progress update on harmonizing these rules with the Commodity Futures Trading Commission (CFTC) like the Treasury’s 2017 Report on Capital Markets recommended. McWilliams replied that “we are working together on updating the rule and we expect to seek comment in the near future,” adding that there are several ways to proceed, to include an interagency rulemaking and stressing that “we are committed to proceeding.” Quarles replied that it should be considered “within the context of existing Federal Reserve Act and Federal Reserve regulations that provide protections to transactions between depository institutions and their affiliates,” adding that “this existing framework should give us comfort in reducing redundancies in the inter-affiliate margin rules.”

Standardized Approach for Counterparty Credit Risk (SA-CCR)

Lucas voiced his concern that higher capital charges will be passed on to end users in over-the-counter transactions, and Quarles replied that he has heard these concerns from end users and will be giving it consideration.

Supplemental Leverage Ratio (SLR)

Lucas discussed a letter from the five CFTC Commissioners to the OCC raising concerns about not offsetting client margin in the SLR. Quarles replied that he is working closely with CFTC Chairman Giancarlo on these issues.

Leveraged Lending

Reps. Jim Himes (D-Conn.), Jesús “Chuy” García (D-Ill.), and Meeks asked about leveraged lending. Quarles said that their analysis of the collateralized loan obligations (CLOs) holding structure is that there is not a risk of a financially destabilizing run from those institutions, even if there is a significant repricing of the leverage loan assets that the CLOs hold. He added that a separate but important question is whether the repricing of those assets could have a magnifying effect on a business downturn, but he does not think that would turn into a financial stability problem. Otting explained that bank management and the Boards of banks should make their own decisions on leveraged lending, adding that the banks should have the people, risk management and policies in place to “play in that space.” He added that he does not have concern about the banks they regulate, but that there may be “indirect transmission of the product,” so he has asked banks to look at their “food chain” and “who they are doing business with.”

Asked why the Fed chose not to activate the countercyclical capital buffer, Quarles responded that it was a decision of the Board of Governors with only one dissent, who determined that their framework for financial stability risk did not call for activating it.

Faster Payment Systems

Reps. Sean Duffy (R-Wis.) and Barry Loudermilk asked about the Fed’s faster payment system, Fedwire, to which Quarles replied that the Fed has been considering Fedwire and that if it is offered, there are statutory standards that will have to be met to ensure there is a level playing field with the private sector, adding that no decision has been made about Fedwire. When asked for specifics on how the Fed system would be interoperable with the private sector network, Quarles had no details since the proposal is still under consideration.

Financial Technology (Fintech)

Rep. Bill Foster (D-Ill.) asked if the same standards for banks should be applied to tech firms as they move into the banking space. Hood replied that they are evaluating the emergence of fintech, but that he has concerns about cybersecurity and data protection. McWilliams noted that she has met with fintech companies to find out how they are partnering with banks and what regulatory obstacles are in their way. Regarding resolution plans for the giant tech firms, she stated that they are “not within our statutory jurisdiction.” Otting stated that clear standards are needed about what partnerships with tech firms and banks should look like.

Rep. Roger Williams (R-Texas) stated that the OCC and FDIC have committed to help drive fintech innovation and asked the OCC how they are helping community and midsize institutions partner with tech companies. Otting replied that the OCC created the Office of Innovation and will allow for national banking fintech charters.

Rep. Stephen Lynch (D-Mass.) asked about state regulation of non-bank financial services companies and whether recent federal proposals would exempt fintech charters from inquiry by secretaries of state and state attorneys’ generals. Otting said that he has always been a supporter of the dual system of state and federal regulation, and he does not feel the proposal wipes out state authority, adding that it is the intent to work with the states in this area.

Rep. Anthony Gonzalez (R-Ohio) noted a PwC report that concluded artificial intelligence (AI) machine learning could increase gross domestic product (GDP) and asked the regulators what barriers are in place preventing financial institutions from using AI. Quarles replied that one of the barriers is the high cost, as the financial sector is currently spending a lot on technology for cybersecurity, as well as consumer protections that are needed from a regulatory perspective. Otting echoed Quarles’ comments, adding that he has seen AI in the anti-money laundering (AML) and Bank Secrecy Act (BSA) space, as well as in the underwriting for credit process.

Data Privacy

Gonzalez asked about data privacy and the European Union’s General Data Protection Regulation (GDPR). Quarles said data privacy is very complex because it plays internationally and domestically, and committed to working with the committee to address it. He commented that the GDPR has impeded some U.S. regulation for the safety and soundness of firms because of the Fed’s inability to access some data with the GDPR standard in place, adding that they are working through these issues but they are an example of the unintended consequences of the regulation.

Capitalization of European Banks

Rep. Andy Barr (R-Ky.) asked Quarles if he is concerned that some of the large European banks are not adequately capitalized, to which Quarles replied that the capitalization of European banks continues to rise. He continued that the U.S. banking system is “more heavily” capitalized but that the difference “has been closing over time,” adding that the “system as a whole does not give me systemic concerns.”

G-SIB Surcharge

Reps. Andy Barr (R-Ky.), Trey Hollingsworth (R-Ind.) and Ted Budd (R-N.C.) asked about the global systemically important bank (G-SIB) surcharge. In response to a question from Barr about why it is appropriate for U.S. regulators to exceed standards set by the Basel Committee and impose more stringent capital and liquidity requirements on U.S. firms, Quarles said it is something that should be considered, particularly in the context of capital requirements not yet implemented domestically that, depending on how they are implemented, could significantly increase capital levels, adding that as they think about how to calibrate various elements of the system, they need to think about it holistically. He declined to give a timeline on reviewing the issue, saying that they are looking now at the complexity of capital regulations as a whole and trying to determine where to calibrate each element, including the G-SIB surcharge.

Diversity & Inclusion

Reps. Joyce Beatty (D-Ohio) and Alma Adams (D-N.C.) asked about diversity and inclusion efforts. Regarding voluntary diversity reporting by regulated entities, Quarles said he has seen a six percent response rate. Otting noted that the OCC found a problem in the way they were asking questions, so they are evaluating how to do so going forward. Asked about plans to increase this reporting, Quarles said they would make it a focus of their supervision and examination practices. Asked if this reporting should be made mandatory, Quarles said that according to their interpretation of the law, they cannot make it mandatory. Asked what diversity trends they have noticed, Otting said they have noticed that in upper levels of management, there is now much more representation of women and minorities. Panelists agreed that the entire organization is responsible for diversity results.

Foreign Banks

Rep. Trey Hollingsworth (R-Ind.) asked about how branches and international holding companies (IHCs) are treated as separate entities, particularly regarding liquidity requirements. Quarles explained that the proposal to base the tailoring rules, particularly the size element, on the consolidated U.S. operations on the IHC and the branch was driven by the Fed’s experience during and since the financial crisis, as branches of foreign banks did require liquidity support from the Fed during the crisis. He said that the Fed looked at the entire operation and not just the branch, and the goal is parity between the two.

Rep. Bryan Steil (R-Wis.) asked about the proposal for capital and liquidity requirements for banks with a foreign parent, and expressed concern that this will raise liquidity requirements for domestic firms of similar size. Quarles said in aggregate across all foreign banking organizations (FBOs) in the U.S., there would be an increase in liquidity requirements, but the great variety of business models of domestic banks would result in much different treatment of firms of the same basic asset size.

Bank Secrecy Act

Rep. Barry Loudermilk (R-Ga.) spoke about his proposed bill that would increase the threshold for currency transaction report (CTR) reporting from $10,000 to $30,000, asking if this was a problem for credit unions. Hood replied that credit unions are burdened by CTR reporting and he is thankful for the proposal.

Insurance Capital Standards

Quarles explained that he is working with the National Association of Insurance Commissioners (NAIC) to develop the “building block approach” to put forward in international discussions that recognizes the U.S.’s insurance capital system (ICS) is an appropriate equivalent approach to be part of the International Association of Insurance Supervisors’ (IAIS) ICS, adding that the U.S. proposal needs to be out “soon.”

For more information on this markup, please click here.