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House Financial Services Committee Hearing with Prudential Regulators

House Financial Services Committee

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

Wednesday, December 4, 2019

Key Topics & Takeaways

  • Community Reinvestment Act: McWilliams said the FDIC is engaged in interagency negotiations with the Fed and OCC on how best to modernize and improve the CRA, adding that the FDIC board has not yet voted on the issue. McWilliams said her goal is to modernize provisions to address digital lending channels, encourage long-term investments, and do more for rural areas and small businesses.
  • Repo Market: McHenry noted that there has been recent volatility in the repo market that required intervention by the Fed, asking what policies might have contributed to this volatility. Quarles replied that a complex set of factors contributed, but not all of them were related to the regulatory framework. He said the Fed has identified some areas where the existing supervision of the regulatory framework may have created some incentives that contributed to the volatility, particularly that internal liquidity stress tests create a preference for central bank reserves over other liquid assets including Treasury securities for the satisfaction of liquidity requirements. Quarles explained that the regulatory framework was intended to be structured such that banks would be indifferent regarding central bank reserves and other forms of liquid assets, particularly Treasury securities, in satisfying high quality liquid asset (HQLA) retention requirements, noting that the liquidity coverage ratio itself does not make any distinction.
  • Volcker Rule: Asked to elaborate on how the Fed views the Volcker covered funds definition as well as the ability of banks to provide this, Quarles responded that the Fed is looking at ways to ensure that they affect the purposes of the statute in a way that allows for the greatest amount of financing for the real economy, all in accordance with the original purposes of the statute. He continued that there are amendments the Fed can make that will facilitate this. He concluded that such amendments are under active discussion that they will propose and solicit comments.
  • LISCC: Loudermilk expressed concerns regarding the lack of clear transparent criteria for designating firms and asked what the Fed plans to do to ensure that LISCC is transparent. Quarles stated that the Fed is considering refinements and revisions to the designation process to make it more transparent.

Witnesses

Opening Statements

Chairwoman Maxine Waters (D-Calif.)

In her opening statement, Waters said the Trump administration has laid out a “dangerous” deregulatory blueprint that has weakened capital and stress testing requirements, the Volcker rule, and the swap margin rule, saying this will threaten economic stability. She said regulators are “opening the door to bad practices” that contributed to the “devastating” 2008 financial crisis and are making “brazen” attempts to weaken the implementation of the Community Reinvestment Act (CRA) under the guise of modernization. Waters noted that the committee will continue to closely scrutinize large bank merger proposals, saying that mergers must serve the public interest and not threaten the economy or the financial system. Waters also highlighted the committee’s continued focus on diversity and inclusion issues, saying that diversity data and policies received by the committee reinforces the position that banks must improve their diversity and inclusion practices.

Ranking Member Patrick McHenry (R-N.C.)

In his opening statement, McHenry thanked the witnesses for prioritizing the implementation of common-sense reforms required by S. 2155. He highlighted the clarification of the Volcker rule and tailoring the requirements for foreign banks as examples of regulatory rightsizing that have been implemented to ensure the economy, small businesses and consumers remain strong and vibrant, though he noted that there is more work to be done. McHenry expressed his concern about the Federal Reserve’s (Fed) open market operations and the wholesale funding markets. He stated that although it is important for the Fed to have independent monetary policy standards, it is necessary for Congress to have oversight over regulatory changes, adding that if “bad regulations” are driving monetary policy, it raises concerns about financial stability, the market and economic growth. He noted that the combined impact of proposed capital requirements, including Basel III and the stress buffer, could have a significant impact on required capital if not thoughtfully implemented. McHenry said it is important to consider the system of capital requirements as a whole to ensure those requirements are appropriately calibrated so institutions can support economic growth. McHenry also highlighted the transition from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR), saying he has concerns about how it will impact consumers.

Rep. Gregory Meeks (D-N.Y.)

In his opening statement, Meeks expressed concerns about the Office of the Comptroller of the Currency’s (OCC) approach to modernization of the CRA, saying it is likely to decouple the link between the CRA and the communities it was designed to serve. He said he looks forward to engaging with the witnesses on this and other issues including nonbank lenders, small dollar loans and broker deposits.

Rep. Blaine Luetkemeyer (R-Mo.)

In his opening statement, Luetkemeyer expressed concern about the Financial Accounting Standards Board’s (FASB) current expected credit loss (CECL) accounting standard. He noted that although statements have been made in multiple congressional hearings that CECL will have a detrimental effect on small financial institutions and low- to moderate-income and minority consumers, the committee has “remained silent.”

Testimony

The Honorable Rodney Hood, Chairman, National Credit Union Administration

In his testimony, Hood said the credit union industry is strong and the National Credit Union Administration (NCUA) is working to ensure a safe and sound credit union system and provide a regulatory framework that is transparent, efficient and improves customer access. Hood said that the NCUA’s examination and supervision program provides for active risk management and early detection of problems, adding that this is critical to preserving the financial strength and well-being of the system. He noted a number of cybersecurity initiatives the NCUA is undertaking, including programs to ensure credit unions have the resources necessary to improve their preparedness and resiliency. Hood noted that the NCUA is also working to reduce, streamline, or eliminate outdated or overly burdensome regulations where possible, including on issues such as bylaw modernization, public unit and nonmember shares, and payday alternatives. Hood also highlighted efforts underway at the NCUA to promote diversity and inclusion including credit union self-assessment tools and initiatives to address supplier diversity.

The Honorable Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation

In her testimony, McWilliams said under her leadership the Federal Deposit Insurance Corporation (FDIC) has made significant progress in strengthening the banking system, ensuring that FDIC-supervised institutions can meet the needs of consumers and businesses, and fostering technology solutions and encouraging innovation at community banks and the FDIC. She said the U.S. banking industry has experienced an extended period of economic growth, noting that the industry is strong and well-positioned to continue to support the U.S. economy. She said that the current interest rate environment may result in new challenges for banks in lending and funding, though the industry is well-positioned to remain resilient throughout the economic cycle due to greater and higher-quality equity capital. McWilliams explained that the FDIC is working to further strengthen the banking system by modernizing its approach to supervision and increasing transparency, tailoring regulations including enhanced prudential standards, stress testing, resolution planning, and the Volcker rule, enhancing resolution preparedness including cross-border cooperation, assessing new and emerging risks including cyber risks and anti-money laundering (AML) issues, and creating a workforce for the future.

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

In his testimony, Quarles gave an overview of the steps the Fed has taken to implement S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act, saying there is a continuing need to ensure the regulatory framework is “coherent and effective.” Quarles explained that the Fed’s recent Supervision and Regulation Report shows that the banking sector is stable, healthy and resilient with robust capital and liquidity positions. He continued that there have been steady improvements to safety and soundness, adding that there has been a gradual decline in supervisory actions at both large and small institutions. He said the Fed is continuing to focus on operational resiliency and cyber-related risks, emphasizing these are among the Fed’s top priorities for the coming year. He stated the Fed has tailored its rules for regional banks and has worked with other agencies to address a range of issues affecting small and community banks, including stress testing requirements and the Volcker rule. Quarles noted that the Fed is paying particular attention to proposed changes to the stress capital buffer, the implementation of Basel III, the transition from LIBOR, the need to “thoughtfully” address new financial products and technologies, and the need for cross-border coherence.

Question & Answer

Community Reinvestment Act

Waters and Meeks asked about the FDIC’s work to modernize the CRA and whether the agencies are working together to find a mutually agreeable path forward. McWilliams said the FDIC is engaged in interagency negotiations with the Fed and OCC on how best to modernize and improve the CRA, adding that the FDIC board has not yet voted on the issue. Asked how the issue will be resolved if the Fed does not agree on a path forward, McWilliams said she did not know how it would be resolved, but highlighted that there is an opportunity now to do more for minority depository institutions and expand what qualifies for CRA credit, adding that she looks forward to working with the committee on this issue. Reps. Steve Stivers (R-Ohio), Scott Tipton (R-Colo.), Alma Adams (D-N.C.), Ben McAdams (D-Utah) and Katie Porter (D-Calif.) also asked about CRA modernization. In response to Tipton, McWilliams said her goal is to modernize provisions to address digital lending channels, encourage long-term investments, and do more for rural areas and small businesses.

Repo Market

Reps. French Hill (R-Ark.), Warren Davidson (R-Ohio) and McHenry asked about the repo market. McHenry noted that there has been recent volatility in the repo market that required intervention by the Fed, asking what policies might have contributed to this volatility. Quarles replied that a complex set of factors contributed, but not all of them were related to the regulatory framework. He said the Fed has identified some areas where the existing supervision of the regulatory framework may have created some incentives that contributed to the volatility, particularly that internal liquidity stress tests create a preference for central bank reserves over other liquid assets including Treasury securities for the satisfaction of liquidity requirements. Quarles explained that the regulatory framework was intended to be structured such that banks would be indifferent regarding central bank reserves and other forms of liquid assets, particularly Treasury securities, in satisfying high quality liquid asset (HQLA) retention requirements, noting that the liquidity coverage ratio itself does not make any distinction. He said that some banks, in assessing how their liquid assets will perform in future periods of stress, have put a preference on central bank reserves. He concluded that this was an issue worth reviewing. In response to Davidson, Quarles said it is important to ensure there is an ample level of reserves, and though there was an expectation that as reserves shrank there would be a price response, it was not expected to be “so dramatic.”

LIBOR Transition

McHenry raised concerns about the transition from LIBOR to SOFR, urging the Fed to ensure SOFR does not cause greater stress on the system or financial instability. Rep. Anthony Gonzalez (R-Ohio) asked if the Fed supports an extension of LIBOR beyond 2021 for existing contracts. Quarles explained that it is not a question of whether regulators will prohibit it, but rather whether it will be available because the banks that participate in the production of LIBOR have indicated they may be unwilling to continue. He said that if LIBOR is still available, the Fed would have to consider how it is being produced.

Deregulation

Rep. Brad Sherman (D-Calif.) expressed concern about broad deregulation, particularly regarding the Volcker rule, swap margin requirements and reducing the leverage ratio for megabanks. Quarles said the Fed has sought to recalibrate the post-crisis reform rulebook to ensure it is not creating “perverse regulatory incentives” and to avoid unintended consequences. He added that a core principle in this process has been to ensure the Fed does not reduce the loss absorbing cushion of institutions, saying he thinks the Fed has succeeded in doing that and that the changes have improved the safety and soundness of the industry.

Resolution Planning and Living Wills

Sherman asked about resolution planning and living wills, calling them valuable tools to help large banks be better organized. McWilliams explained that the living will process has evolved since its inception as part of Dodd-Frank and that now the FDIC has enough information that it can hone in on the things that are essential to resolving a bank, adding that the FDIC is trying to avoid having banks update 20,000 page submissions without looking at essential underlying issues.

Diversity and Inclusion

Meeks noted that a recent Fed report advocated for board candidates to have diverse experience, rather than the diversity of the board members themselves. Quarles said he believed that was the intention of the language, saying that as a firm considers the composition of its board, it should consider all of the attributes of the board members to ensure there is diversity.

Basel III Implementation

Rep. Frank Lucas (R-Okla.) asked how the agencies plan to move forward with the implementation of Basel III and how they plan to analyze its impact to ensure coherence and capital neutrality. Quarles noted that it is important to maintain the current level of loss absorbency in the industry, and to do that the agencies must look at implementation as a package rather than take a piecemeal approach. He added that it is important to ensure that industry is maintaining its capital level and it is capital neutral. McWilliams agreed that a comprehensive and holistic approach is best, adding that the Basel Committee can do more to analyze the impact of the rules by conducting quantitative impact studies.

Volcker Rule

Lucas asked if Quarles would commit to take into consideration how important it is for banks to make long-term investments while working to finalize the Volcker rule, to which Quarles replied he would take it into consideration. Gonzalez asked Quarles to elaborate on how the Fed views the Volcker covered funds definition as well as the ability of banks to provide this. Quarles responded that the Fed is looking at ways to ensure that they affect the purposes of the statute in a way that allows for the greatest amount of financing for the real economy, all in accordance with the original purposes of the statute. He continued that there are amendments the Fed can make that will facilitate this. He concluded that such amendments are under active discussion that they will propose and solicit comments. McWilliams echoed Quarles’ statements and emphasized that capital investments are critical.

CECL

Luetkemeyer asked numerous questions about CECL, calling it a “terrible” accounting standard. Quarles said that bank regulatory agencies have decided together that they will phase in the “effective CECL” over three years to evaluate its impact on banks. He explained that if there is a large increase in the reserve position, then part of the overall assessment of Basel III and CECL will include recalibrations. Stivers asked whether the Fed will consider giving institutions credit for their CECL reserves in. Quarles said that the Fed has not yet made a decision until it sees how CECL operates in the real world, but that is something that must be on the table. Tipton noted the effect of CECL on access to capital for regional banks, to which Quarles replied that there is a limit to what the Fed can do regarding accounting standards because the Fed does not set them. He continued that the Fed will continue to monitor the effects of CECL on both the industry and individual institutions during the three-year phase-in.

Data Privacy

Luetkemeyer expressed concerns about data aggregators, screen scraping, and the risks these practices pose. Asked what regulators can do to address is, McWilliams said it is concerning to her as both a regulator and as a private citizen, and though there are a number of privacy laws, they largely fall under the jurisdiction of the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC). Hood replied that he is also concerned and will work with the CFPB to address it. Hill asked if the regulators support the use of application programming interfaces (APIs) for access to consumer data by aggregators. The regulators agreed they support the use of APIs.

Corporate Debt

Rep. Bill Foster (D-Ill.) asked about the impacts of growing corporate debt. Quarles replied that corporate debt has been growing but the debt service burden has not been growing due to low interest rates. He said the structures where the riskiest debt is held are generally not runnable structures and that the terms of the leveraged lending are being sold into collateralized loan obligation vehicles. He continued that there is much less of a financial stability risk but he does think there is a possibly that there could be a decline in the value of these assets, which could exacerbate a future downturn. Asked how the Fed models this debt in their stress testing, Quarles replied that the models take into account expected losses of different classes of assets, including the credit quality of these assets. He continued that the model does not rely entirely on the bond ratings for determining expected losses and he believes that there are supervisory actions that agencies can take through the shared national credit program to address this issue. He said the Fed has looked at leveraged lending at the last two shared national credit examinations, and where they have seen practices that affect safety and soundness, they have taken supervisory action.

Stress Testing

McAdams stated that as the Fed continues to contemplate the stress capital buffer, he would like to ensure that stress testing regime remains vigorous. He noted his concern as to whether this can be completed by 2020. Rep. Ann Wagner (R-Mo.) asked whether the Fed expects to have the stress capital buffer rule finalized in time for the 2020 comprehensive capital analysis and review. Quarles stated that they are still aiming to have it done in time for the stress testing cycle but admitted that time is short, and as such, the Fed is undecided as to whether it would be reproposed or proceed in a different administration fashion. He continued that the Fed is always looking at all elements of the current regulatory framework to determine whether a particular calibration is out of sync.

FedNow

Rep. Denver Riggleman (R-Va.) asked Quarles why he was the lone dissenter in reference to the FedNow real-time payment system. Quarles stated that the cost estimates were considered during the approval process, and the ability to recover the cost is a statutory requirement. He said the Fed expects the cost recovery will be achieved over an extended period of time.

CCAR 

Reps. Trey Hollingsworth (R-Ind.) and Wagner asked about CCAR and when the rule is expected to be released, specifically emphasizing the need for CCAR to be more transparent and aligned with some of the stress capital buffer rules. In a response to a question from Wagner regarding the delay in issuing the rule, Quarles noted that the proposal raises a number of complex issues, including the desire to maintain the quantitative aggregate of loss absorbency. Quarles stated that in order for CCAR to be effective for the next cycle, some elements of the rule would have to be released as final as opposed to proposed. Quarles continued that the Fed has the ability to pursue such an approach but that it has not yet determined if that is the best path forward.

LISCC

Loudermilk expressed concerns regarding the lack of clear transparent criteria for designating firms and asked what the Fed plans to do to ensure that LISCC is transparent. Quarles stated that the Fed is considering refinements and revisions to the designation process to make it more transparent.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.