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Senate Banking Committee Hearing with Financial Regulators

Senate Committee on Banking, Housing, and Urban Affairs

“Oversight of Financial Regulators”

Tuesday, May 12, 2020

Key Topics & Takeaways

  • Inter-Affiliate Initial Margin: McWilliams said that the regulators are aware of the unnecessary burdens initial margin poses for institutions, saying they plan to finalize the proposal once they determine the impacts of the various measures that have been put in place to respond to the pandemic.
  • Collins Amendment: Quarles explained that currently the banking system is experiencing an inflow of safe assets, and that growth in their balance sheets creates capital constraints. He continued that if adjustments are not made, that inflow of safe assets will ultimately cause banks to have to turn away customers. Quarles said that the best way to approach this is to temporarily exclude those safe assets from the denominator of the leverage ratio, which does not work under the current formulation of the Collins Amendment. He said that although the amendment is a useful tool for ensuring the leverage ratio is not weakened, the ability to provide flexibility would be useful now. He said that under the Collins Amendment the Fed can change the numerator, but he does not think that is what is called for in this situation and would weaken the amount of leverage protection across the whole portfolio.  
  • Federal Reserve Lending Facilities: Asked how quickly the Main Street and Municipal Liquidity Facilities would be operational, Quarles said that while a majority of the facilities are already operational, those two facilities are innovations in response to this crisis. He continued that it is important for the Fed to do the complicated technical work to ensure they are rolled out effectively. Quarles added that this is the top priority for the Fed and they intend to roll these facilities out quickly, in weeks rather than months.

Witnesses

Opening Statements                   

Chairman Mike Crapo (R-Idaho)

In his opening statement, Crapo said that in the time since the federal prudential regulators last testified before the committee, the world has been wracked by the physical and economic impacts of the COVID-19 pandemic. He continued that Congress and the administration have taken extraordinary action to mitigate the impact of the pandemic and provide conditions that will lead to an economic recovery, adding that the passage of the CARES Act has been central in these efforts. He noted that the legislation authorized the regulators to take certain emergency action to provide liquidity to the marketplace, as well as to take action regarding lending limits, the community bank leverage ratio, troubled debt restructuring, CECL, and debt guarantee programs, among others. Crapo said that U.S. banking organizations have built significant levels of capital in excess of required minimums and can use their resources to meet the needs of affected borrowers and lend to families and businesses. He encouraged finding ways to increase lending, highlighting the Federal Reserve (Fed) lending facilities, some of which are already fully operational, while the others must be stood up quickly to provide this important financial lifeline. He concluded with the acknowledgement that it is a substantial challenge to craft a regulatory response in this time of need while ensuring the safety and soundness of the financial system.

Ranking Member Sherrod Brown (D-Ohio)

In his opening statement, Brown said the regulators have two basic jobs: to ensure the financial system is safe and strong so a public health crisis or natural disaster does not also turn into a financial crisis; and to ensure the banking system is getting money to people who grow the real economy, saying the regulators are failing at both. He noted that the country may not be in a financial crisis in the technical sense, but for millions of families, this is already an economic crisis. He said the regulators are “too eager” to provide regulatory relief and cautioned that relying on trickle-down economics does not work. He said this economic crisis should serve as an opportunity to rethink old habits, not “gut” more rules. He criticized that the Office of the Comptroller of the Currency (OCC) is moving ahead with “dismantling” the Community Reinvestment Act (CRA) even though the pandemic has disproportionally hit minority and low-income communities, adding that these are the same communities hardest hit by the 2008 financial crisis.

Testimony

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

In his testimony, Quarles said the last two months have been a time of “exceptional economic hardship,” noting that Congress has acted swiftly to address this hardship. He outlined the Fed’s approach to supporting the nation’s economy, maintaining the supply of credit, and reducing the economic impact of the measures taken to respond to public health concerns. He said the measures adopted to contain the pandemic triggered a deep, abrupt, and global financial shock and uncertainty “cascaded” across the financial system. Quarles noted that the reforms that followed the 2008 financial crisis raised the quantity and quality of bank capital, established higher levels of liquidity, required improvements in risk management, and improved operational resiliency. He continued that these reforms allowed banks to keep their doors open and their lights on after a shock, and as a result, banks entered this crisis in a position of strength. Quarles said that over the past two months, the Fed took more than 30 supervisory and regulatory actions to ensure financial institutions could use this strength to support consumers, households, and businesses, and because of these measures, banking organizations are well-positioned to serve as a source of strength, not strain, in the current crisis, able to lend to creditworthy firms, absorb new deposits from households and businesses preparing for the difficult road ahead as well as process a flood of transactions from investors responding to higher volatility. He concluded that because of this strength, banks have helped stabilize the financial system and restore market function.

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

In his testimony, Otting said that over the last two months, the OCC has worked with the other federal banking agencies to respond to the public health emergency. He outlined how this coordination helped to provide rapid clarity and guidance to encourage OCC regulated entities to work with consumers, businesses and communities facing economic hardship. He recognized that there is still more to do to ensure banks remain safe and sound to serve their communities, noting that America’s banks entered this crisis well-equipped to play a role in the federal relief programs created by the CARES Act. He continued that capital and liquidity are strong and asset quality is good, and banks have acted quickly to provide relief to customers and communities by providing Paycheck Protection program (PPP) loans, mortgage forbearance and foreclosure relief. Otting said that the OCC is working to support the orderly function of the banking system and is in regular communication with the banks it supervises to understand the challenges they face and work through issues, noting that the OCC has issued 40 pieces of guidance, statements and interim final rules that clarify regulatory expectations regarding capital, liquidity, accounting and customer accommodation. He added that the OCC has also implemented enhanced market data collection to closely monitor the markets and provide real-time awareness of the financial condition of the banks.

The Honorable Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation

In her testimony, McWilliams emphasized that this economic challenge did not originate within the banking system, but rather emanated from an exogenous shock that is impacting the global economy. She said the nation’s banks entered the crisis with aggregate equity over $2.1 trillion, which translated to an average common equity Tier I capital ratio of 13.21 percent. She said banks are well-positioned to support individuals and businesses through lending and other financial remediation. McWilliams explained that to enhance the resiliency of the banking system, the Federal Deposit Insurance Corporation (FDIC) has encouraged banks to work with affected customers and communities and increased flexibilities for banks to meet the needs of customers, foster small business lending, protect consumers, increase financial options, and is actively monitoring the financial system. She added that their supervisory and regulatory response is guided by a focus on enabling banks to best serve their communities during this difficult time. She said that as the FDIC encourages banks to take prudent steps to work with customers, they are mindful of the most vulnerable groups hardest hit by the pandemic and resulting economic shocks. McWilliams concluded that the FDIC continues to evaluate open rulemakings and will prioritize rules that are necessary or appropriate at this time that will not disrupt or add unnecessary uncertainty to the market.

The Honorable Rodney E. Hood, Chairman, National Credit Union Administration

In his testimony, Hood said the credit union system is vital to the American economy and began this emergency in a strong financial position. He added that data shows low delinquency rates, healthy loan growth, sufficient liquidity, and a very robust insurance share fund. He explained that the National Credit Union Administration (NCUA) continues offsite supervision and monitoring and has swiftly implemented the provisions of the CARES Act affecting credit unions. He said that capital and liquidity are pillars of strength for the safety and soundness of the credit union system, and the NCUA has taken several actions to improve the flexibility and strength of the central liquidity facility. He noted the NCUA is working with the Small Business Administration (SBA) to provide guidance and resources so credit unions can continue to participate in the PPP. Hood added that regulatory relief to ensure federally insured credit unions remain operational and liquid will help the NCUA fulfill its critical mission of protecting the safety and soundness of the system.

Question & Answer

Inter-Affiliate Initial Margin

Sen. Thom Tillis (R-N.C.) noted that the regulators were poised to move forward on inter-affiliate initial margin but the crisis has directed energies elsewhere, asking McWilliams for an update on when the proposal is likely to move forward. She responded that the regulators are aware of the unnecessary burdens initial margin poses for institutions, saying they plan to finalize the proposal once they determine the impacts of the various measures that have been put in place to respond to the pandemic. She explained that the FDIC, OCC and Fed are working together to determine the best path forward to be able to finalize the proposal issued in December.

Collins Amendment

Sen. Pat Toomey (R-Pa.) said that capital requirements should be countercyclical where they can be, adding that this is why he supported the Fed’s decision to remove risk-free assets from the supplemental leverage ratio denominator. He noted that this issue also arises in the context of the Collins Amendment in the Dodd-Frank Act, which created a statutory minimum capital requirement, asking whether Congress should consider modifying this amendment. Tillis also noted the Collins amendment, asking Quarles what the Fed can do administratively on this issue absent congressional action. Quarles explained that currently the banking system is experiencing an inflow of safe assets, including an increase in Treasury holdings, and that growth in their balance sheets creates capital constraints. He continued that if adjustments are not made, that inflow of safe assets will ultimately cause banks to have to turn away customers. He noted that this is a different situation than if the leverage ratio needed to be amended due to losses. Quarles said that the best way to approach this is to temporarily exclude those safe assets from the denominator of the leverage ratio, which does not work under the current formulation of the Collins Amendment. He said that although the amendment is a useful tool for ensuring the leverage ratio is not weakened, the ability to provide flexibility would be useful now.

In response to Tillis, Quarles said that the leverage capital framework for banks, particularly the largest banks, is complex, noting recent changes to the supplemental leverage ratio mechanism at the holding company level. He said he thinks it is possible to make changes to the supplemental leverage ratio mechanism at the depository institution level without violating the Collins Amendment, but this would be “trickier” for the Tier I leverage ratio. He noted that any change made would be temporary and targeted to this particular situation. He said that under the Collins Amendment they can change the numerator, but he does not think that is what is called for in this situation and would weaken the amount of leverage protection across the whole portfolio. Tillis noted he will follow up with McWilliams on this rulemaking and that this is very important to get done. While he understands other events have taken over, he noted we should be able to multitask and move forward with this rulemaking.

LISCC

Sen. Thom Tillis (R-N.C.) noted UBS was recently removed from LISCC, and in addition the GAO recognized the structure for LISSC was not set up in the accordance of the law. Tillis suggested the Fed remove all institutions from LISCC and recommend the Fed do a comprehensive re-write rather than a piecemeal approach. Quarles responded they are developing a comprehensive approach to LISCC classification. He noted he has stated publicly, post S. 2155 and the regulations for that law, they now have a clear framework on Category 1, LISCC institutions, and are working on implementing regulation that will allow this to be done comprehensively.

Federal Reserve Lending Facilities

Multiple senators raised concerns and asked clarifying questions about the Fed’s lending facilities that have been stood up in response to the pandemic. Asked by Crapo and Sen. Mark Warner (D-Va.) how quickly the Main Street and Municipal Liquidity Facilities would be operating, He continued that it is important for the Fed to do the complicated technical work to ensure they are rolled out effectively. Quarles added that this is the top priority for the Fed and they intend to roll these facilities out quickly, in weeks rather than months.

Toomey expressed his hope that the Fed will deem nonbank lenders as eligible participants in the Main Street facility. Quarles said a decision has not yet been made on that consideration, but it is something they are looking at.

Sen. Kyrsten Sinema (D-Ariz.) expressed concern that the terms of eligibility for the Main Street facility are too restrictive, asking Quarles to explain the rationale for requiring that loans have a pass rating as a precondition for qualifying. Quarles explained that the Fed is required by law to structure the 13(3) facilities so that loans are made to solvent entities, and the various metrics included in the Main Street facility are designed to try to balance that with providing a broad reach. He noted that the pass rating would be measured as of the end of 2019, pre-COVID-19.

Sen. John Kennedy (R-La.) asked why the Fed set a minimum loan limit of $500,000 for the Main Street lending program. Quarles explained that the strategy was such that the PPP would serve the smallest businesses and the Main Street program would serve those that were larger, adding that while they are taking input, they are not actively considering lowering the minimum loan amount.

Reed noted that non-profits do not qualify for the PPP, asking what the Fed will do for non-profits in its various lending facilities. Quarles explained that non-profits are not directly comparable to corporations, and the measures of whether a corporation is solvent for the purposes of participating in the Main Street lending facility do not apply to non-profits. He said he is working with the Treasury Department to determine what the appropriate measures are, and that work is underway.

Regarding the municipal facility, Crapo and Sen. Catherine Cortez Masto (D-Nev.) raised concerns that the caps on population will limit which localities can apply independently versus applying through their state government, asking how smaller communities will benefit. Quarles said that the Fed has tried to balance the need for speed of deployment of the facility with the effectiveness of that deployment, and in general have tried to create an administrative structure for the facility that allows the Fed to work directly with larger jurisdictions and have them distribute down. He noted that developing a structure that would allow the Fed to interact with all localities would take a significant amount of time, in turn affecting their ability to disperse funds quickly.

Sen. Martha McSally (R-Ariz.) said the Term Asset Loan Facility is designed to provide liquidity and credit for consumers and businesses, asking if the Fed is considering expanding it to meet consumer needs. Quarles said that they are accepting input on what additional types of securitization should be considered in that area, but are not suggesting any specific changes at this time.

Guidance for Mortgage Servicers

Sen. Martha McSally (R-Ariz.) said that no specific actions have been taken to date regarding guidance for servicers of mortgage-backed securities to ensure there is ample liquidity to process and manage forbearance requests, saying this is critical to the stability of the economy. Quarles agreed that maintaining liquidity in this area is important. He noted that the housing regulators have taken action to provide some liquidity in this sector and the Fed is monitoring it closely.

Bank Dividends

Sens. Brian Schatz (D-Hawaii) and Brown expressed concerns about banks paying dividends during this time. Quarles explained that many of the largest banks have suspended a great bulk of their capital distributions via the suspension of share repurchases, though regarding dividends the regulatory framework is built around annual stress tests that assess capital needs, and the Fed is conducting additional analysis to examine the effects of the current economic situation, which will be completed before the next dividends are set to be paid.

Community Reinvestment Act

Sens. Jack Reed (D-R.I.), Bob Menendez (D-N.J.), Warner and Brown criticized the OCC and FDIC’s proposed modernization of the CRA, particularly that the OCC continues to move forward with the proposal during the pandemic. McWilliams noted that the rulemaking process commenced well before the pandemic and the agencies have done extensive outreach on the proposal. Otting added that strengthening the CRA is important for increasing the dollars that flow into communities that need it.

Paycheck Protection Program

Menendez asked whether the regulators have provided guidance on how to set up a PPP lending process that honors fair lending requirements. Otting explained that the OCC issued a bulletin to banks encouraging them to document their lending practices and procedures and stressed an emphasis on lending to low- and moderate-income (LMI) areas. McWilliams added that the FDIC has sent a letter to financial institutions that stipulates how this lending should be done and added that the FDIC will enforce fair lending laws.

Sen. Jon Tester (D-Mont.) asked how the regulators are ensuring that PPP dollars are going to businesses actually impacted by the pandemic. McWilliams explained that the banks rely on borrower certification. She continued that this is less of a concern for community banks who can more easily determine the legitimacy of the certification, but is more difficult for larger institutions.

Sen. Doug Jones (D-Ala.) asked if the regulators are coordinating with the SBA and Treasury to help lenders understand the loan forgiveness provisions of the program. Otting said that all regulatory agencies consulted with SBA and Treasury on the program, and will need to give clarity to banks about the process of loan forgiveness when the time comes.

Troubled Debt Restructuring

Cortez Masto asked about troubled debt restructuring, noting that the language in the CARES Act expires at the end of the calendar year or when the emergency declaration is ended, asking what the impact would be if that happens before the end of the year. McWilliams responded that the economic impact of the 2008 crisis was “devastating” because banks were at that time reluctant to modify loans knowing they would be classified as troubled debt restructuring. She continued that now, loans that are modified as a result of the pandemic are not classified as troubled debt restructuring to help avoid these lasting impacts that could affect banks’ ability to respond to shocks.

Federal Reserve Balance Sheet

Kennedy asked about the size and growth of the Fed’s balance sheet throughout the crisis. Quarles said that in early February the balance sheet was $4.2 trillion and is currently between $6.5-7 trillion. He said any further increase will be a function of the take-up of Fed facilities and of the growth of reserves in the banking system which could be significantly larger is there is another flight to cash from market securities.

For more information on this hearing, please click here.