HFSC Hearing: The Tangled Web of Global Governance: How the Biden Administration is Ceding Authority Over American Financial Regulation

House Financial Services Committee

Subcommittee on Financial Institutions and Monetary Policy

The Tangled Web of Global Governance: How the Biden Administration is Ceding Authority Over American Financial Regulation

Tuesday, November 7, 2023

 

Topline

• Republicans argued that international regulatory regimes should not determine U.S. banking rules and called for greater transparency in the process to ensure elected officials have oversight.
• Democrats stressed the importance of U.S. leadership on international financial regulations when confronting the global economy and issues with credit access.

Witnesses

• Bryan Bashur, Director of Financial Policy, Americans for Tax Reform
• Thomas Hoenig, Distinguished Senior Fellow, Mercatus Center, George Mason University
• Christina Parajon Skinner, Assistant Professor of Legal Studies & Business Ethics, Wharton School, University of Pennsylvania
• Renita Marcellin, Advocacy and Legislative Director, Americans for Financial Reform

Opening Statements

Subcommittee Chair Andy Barr (R-Ky.)

During his opening statement, Barr warned that the Basel Committee will increase the power of unelected and foreign bureaucrats over the US financial system without adequate congressional oversight and engagement. He discussed a letter from Full Committee Chairman Patrick McHenry (R-N.C.) and himself to the Government Accountability Office requesting a report of all concerns and proposals submitted to the Basel Committee by U.S. prudential regulators for which a response remains pending.

 

Barr also described a global web of governance stemming from the tie between the Basel Committee and the Bank of International Settlements (BIS), the Federal Stability Oversight Council (FSOC) of the U.S. Treasury Dept. and Network for Greening the Financial System (NGFS). Barr said this tangled web of global governance works behind closed doors with the U.S. prudential regulators developing policies that reflect the Biden Administration and international community’s objectives for global banking, rather than U.S. objectives. He cited as examples of this international influence over the U.S. banking regulatory system the Principles for Climate-Related Financial Risk Management for Large Financial Institutions issued by the prudential regulators and the Pilot Climate Scenario Analysis Exercise conducted by the Federal Reserve Board.

 

Subcommittee Ranking Member Bill Foster (D-Il.)

In his opening statement, Foster explained that participation in the Basel Committee allows the U.S. to lead the process of setting global banking regulation standards, which is devalued by ignoring this fact. He referenced former Treasury Secretary Mnuchin’s view that Basel III is largely about bringing the standards used in E.U. and Asia in line with the U.S. Foster concluded that banking regulators have no statutory obligation to adopt all the recommendations from the Basel Committee and that U.S. policies should support economic growth while responding to global economic risks in banking.

 

Full Committee Ranking Member Maxine Waters (D-Calif)

In her opening statement, Waters criticized Republicans’ commitment to eliminating funding for banking regulatory agencies like the CFPB and legislative gamesmanship pushing the federal government toward another shutdown that will economically impact the U.S. She said the U.S. must provide global leadership on financial regulations in international forums such as the Basel Committee.

 

Testimony

Bryan Bashur, Director of Financial Policy, Americans for Tax Reform

In his testimony, Bashur discussed how federal regulators are using the Basel III regulations to circumvent the requirement that Congress set banking policy. He explained that federal statute does not authorize federal regulators to set banking policy using international forums and agreements. Bashur noted that capital requirements on U.S. banks are coming from the Basel Committee unconstitutionally, which will ultimately harm the rulemaking process. Bashur called on Congress to pass legislation that would prevent international financial agreements from being enacted without the authority of Congress.

 

Thomas Hoenig, Distinguished Senior Fellow, Mercatus Center, George Mason University

In his testimony, Hoenig noted that since the 1980s, banking regulators have assigned risk weights to assets proportional to their equity-to-asset ratio, or leverage ratio. He said the Basel III model arises from an opaque process and would be difficult and costly to implement. Hoenig concluded that the Basel risk-weighted capital measures preclude straightforward analysis of a bank’s balance sheet and prevent banks from evaluating credit risk based on market factors in favor of risk factors motivated by economic policy.

 

Christina Parajon Skinner, Assistant Professor of Legal Studies & Business Ethics, Wharton School, University of Pennsylvania

In her testimony, Skinner said Congress must prevent federal banking agencies from engaging in mission creep and exceeding their statutory authority. She explained that federal regulators are using international agreements, including the Basel Endgame Rule, to implement policies outside of their mandate in areas like climate change. She said there is no statutory basis for implementing Basel III as it’s neither a treaty nor binding international law, and it risks injecting politics into banking regulations. Skinner stated that regulators should not be able to hide behind the opaque Basel III process to justify their actions.

 

Renita Marcellin, Advocacy and Legislative Director, Americans for Financial Reform

In her testimony, Marcellin discussed the risks banks run if banks lack adequate capital to endure a financial crisis. She explained that banks are publicly charted entities that would benefit from higher capital requirements in terms of lending growth. Marcellin noted that Basel III would only increase capital requirements for less than 50 banks in the U.S. She said the U.S. banking industry can only be competitive if it mirrors international standards and emphasized that the U.S. must remain competitive when it comes to combatting climate change. She concluded that Congress must put the needs of all Americans ahead of the needs of a handful of large banks.

 

Question & Answer

Opacity in Basel Committee Meetings

Barr asked Hoenig if he had full information about Basel while he was at the FDIC. Hoenig replied that the FDIC staff were sent to discuss Basel in Europe and had the option to brief the Board on the meeting. He noted that the Board often did not receive this briefing until months after the meeting.

 

Barr asked the witnesses to discuss the opacity of the Basel Committee. Skinner said it is difficult to know what issues are being discussed because the international agencies operate behind closed doors. Skinner warned that while international standards must be approved by Congress, many regulatory agencies will stretch their authority to act upon international agreements.

 

Reps. Rep. Ralph Norman (R-S.C.), John Rose (R-Tenn.) and Monica De La Cruz (R-Texas) asked how Congress can understand how the U.S. regulators are engaging in Basel Committees. Hoenig explained there are no minutes kept on those meetings and said Congress would have to require US regulators to provide notes or minutes of the meetings. Bashur replied that Congress should have access to meeting minutes and should require briefings from international regulators, citing the American Financial Institution Regulator Sovereignty and Transparency Act (H.R.4823) that was marked up by the HFSC last summer as the first step.

 

Basel III: International Influence Over U.S. Banking Regulation or U.S. Influence Over International Banking Regulation

Barr and Rep. Bill Posey (R-Fla.) asked the witnesses if international regulatory bodies should have the predominant say in U.S. banking regulations. Bashur said no. and explained that the US has given too much authority to federal regulators to make policy instead of enforcing policy. Hoenig said there is a need for international cooperation on banking but warned that Basel III will politicize the banking regulatory system because it is too opaque.

 

Waters and Rep. Nydia M. Velázquez (D-N.Y.) asked if it would be a mistake for the US to opt out of the Basel capital requirements. Marcellin answered yes and cited the string of bank failures earlier this year as proof of the need for more stringent capital requirements. Waters asked if Congress should encourage international cooperation on banking regulations. Marcellin said that US banks are the most globally interconnected banks and federal regulators need to have global insight on how these banks operate and respond to global issues.

 

Rep. Blaine Luetkemeyer (R-Mo.) asked how regulators are justifying implementing the Basel III rule without Congressional authority. Skinner explained that it is being implemented via the Dodd-Frank Act and is motivated by the collapse of several banks earlier this year. Bashur said that the FDIC could claim to use the International Lending Supervision Act for implementation.

 

Rep. John Rose (R-Tenn.) asked how Congress can assert itself as the one who makes financial regulatory policy in America. Skinner stated that Congress should insist that there is a statutory basis for engaging in these international forums.

 

U.S. Competitiveness Under Basel III

Foster asked what statutory obligations federal regulators have under Basel. Marcellin said regulators usually adapt the recommendations before they propose them to US markets. Foster asked if there is value to the US to participate in these discussions. Marcellin answered that there is substantial value in Basel’s recommendation to the US, including the supplemental leverage ratio which was created based on Basel discussions.

 

Rep. Roger Williams (R-Texas) asked whether the Basel III regulations will give Europe an advantage over the US. Skinner noted that several European banks have already decided that some parts of Basel are not for them. He explained that while Europe has always looked for guidance from the U.S. when it comes to capital lending, now the situation has reversed. Skinner explained that the Bank of England stated it will not implement parts of Basel to remain competitive.

 

Rep. Young Kim (R-Calif.) asked if the reason for international harmonized capital standards is to create a level playing field for competition among banks from different countries. Skinner said there is a difference between international harmonization and Basel Accord compliance. She noted that different jurisdictions adopt and ignore compliance standards, the U.S. would adopt a platinum-plated version of Basel III and provided as an example the difference in loan weighting in the EU and U.S.

 

Basel III & U.S. Banking Market Structure

Kim said the Silicon Valley Bank failure is being used as a red herring to increase capital requirements by as much as 16% when it was caused by mismanagement, supervisory failures, and a modern version of a bank run. She expressed concern that the proposed regulations would create a more centralized system of banking, moving the U.S. away from a market-based system to banking as a utility service for the public. She asked what would happen to the US economy were Basel III adopted. Skinner said the U.S. would become a centrally planned economy where banks are a mechanism of distributing capital based on policy preferences.

 

Kim asked how the U.S. banking system differs from the EU or Asia. Skinner explained that the three-tiered model of banking in the U.S., comprised of large, regional, and community banks, is a source of strength, which increases access to credit for small businesses because they serve different markets. Skinner said the compliance costs of Basel III would create a two-tiered system since only large banks can afford the costs and community banks would be exempt from complying.

 

Kim asked whether Federal Reserve Chair Barr’s assertion that Basel III would only apply to very large banks with over $100 billion in consolidated assets would produce any negative implications impacting community banks. Bashur said the market exception applies to a bank with trading assets and liability at $5 billion and would subject them to compliance. He added that this will impact consumer credit products, like credit cards because many community banks can only offer these products through partnering with large banks.

 

Capital Requirements

Foster asked if there is an objective way to set bank capital requirements. Hoenig answered that there is, but emphasized Basel is not the answer. He explained that Basel assumes that federal regulators have more information than they have and creates misaligned risk assessments for capital allocation. Velázquez asked the witnesses to explain how regulators will implement Basel’s capital requirements. Marcellin said that the Basel rule will lower capital requirements for most banks and noted that studies continue to show that higher capital requirements are beneficial to both banks and consumers. Velázquez asked the witnesses to explain how the on-ramp for capital requirements would impact credit accessibility for small businesses. Marcellin explained that banks will have time to adjust to the capital requirements and noted that community banks will not be affected by Basel III.

 

Rep. Al Green (D-Texas) asked if banks with more capital perform better than those with less capital. Marcellin said that banks with better access to capital were able to perform better during the 2008 financial crisis and the pandemic.

 

Mortgage Market & Capital Requirement Impacts

Rep. Brad Sherman (D-Calif.) asked the witnesses why Basel III ignores private mortgage insurance in the risk weighting for mortgage loans, calling this a stupid idea. No witness responded.

 

Rep. David Scott (D-Ga.) noted that under Basel 3 banks would need to hold more capital against mortgages and mortgages with downpayments of less than 20%, and asked how that would impact a policy objective to preserve the ability of minority borrowers to obtain residential mortgages under Basel III. Marcellin said that non-bank lenders originate more purchase mortgage loans than banks and account for a greater share of mortgages issued to minorities. She noted that when capital requirements were lower, banks maintained a 400-year-old practice of refusing loans to minorities. Scott asked how Basel III would impact bank incentives to make loans for low-income Americans. Marcellin said the 50% risk weight for mortgages will remain the same for low-income borrowers and cautioned against distracting from the overall goal of financial stability given that non-banks lead in minority lending and will not be impacted.

 

Scott asked how regulators should bank capital requirements to ensure low- and middle-income Americans do not subsidize borrowing costs for wealthier individuals. Bashur said banks should determine risk and laws like the Community Reinvestment Act provide direction as to how banks should concentrate mortgage lending.

 

Norman discussed the lack of affordable credit access in the real estate industry as a major crisis preventing new projects. He asked for solutions to this issue other than tax credits. Hoeing said the relative weights for some mortgages vary to make smaller banks more competitive with larger banks. He explained that a primary problem with Basel III is using rules to influence behavior rather than safety and soundness. Norman said credit underwriting should be driven by bank business acumen and banks should be answerable to shareholders in this process, not regulators.

 

Rep. Juan Vargas (D-Calif.) asked if climate regulations in Basel III Endgame would make it more difficult to get a mortgage. Skinner said it’s unclear because there hasn’t been a cost-benefit analysis of Basel III. She added that lending will be dispersed for first-time homeowners due to these regulations. Marcellin said most mortgages issued to minorities are purchased by Freddie Mac and Fannie Mae, which are not subject to Basel III capital requirements.

 

Tax Equity Investments & Risk Weighting Impact

Sherman discussed the impact of capital requirements favoring multimillion and billion-dollar investments and securities made by social elites and downplaying Main Street business loans, which happens because prudential regulators identify more closely with social elites as an educated class. He said credit risk is the focus in Basel III and is overly associated with small business risk, but interest rate risk is given minimal attention even though that caused Silicon Valley Bank to collapse. Sherman stated that because the decisions concerning interest rate risk come from educated elite bankers, regulators refuse to adequately scrutinize these risks.

 

Sherman explained that Basel III would increase the risk associated with tax equity investments for green energy by a factor of four. He asked the witnesses to think of a reason why we should punish banks for investing in tax credit projects designed to encourage green energy. Marcellin replied that she couldn’t think of a reason and that few benefitted from these programs, namely J.P. Morgan and Wells Fargo. Sherman said rules for high-quality corporate exposures in Basel III are designed to discriminate against making Main Street loans and push banks toward concentrating credit in large loans and securities.

 

Rep. Sean Casten (D-Ill.) noted that present capital requirements assign 100% risk weight when banks invest in tax equity projects, unless the investment constitutes more than 10% of their capital, in which case the figure would increase to 400%. Under Basel III, some classes of equity would increase to 400% regardless of other factors on the balance sheet. In addition, tax equity in community housing would stay under the old rule, but tax equity for clean energy would go under the new rule. He asked whether the difference in the risk profile of these types of tax equity projects corresponds to the different risk weights assigned to them under Basel III. Marcellin said the Congress authorized preferential treatment for housing and low-income community development programs. Casten asked whether risk should correspond with weighting. Marcellin said the risk weighting that reflects differences in tax-funded and private-equity funded projects would make more sense.

 

Climate Change Policy Generally

Vargas asked each witness if they believed in climate change. Hoenig said that banks have been dealing with climate change for centuries and noted banks know what is best when it comes to risk assessment. Skinner said one can separate the issue of climate change and the issue of whether regulators should have the ability to use financial regulations to tackle it. Marcellin answered yes.

 

Rep. William Timmons (R-S.C.) asked if there is a high risk that pressure from outside groups will change US policies. Skinner warned that the United States is facing outside pressure to divest from brown assets and towards green assets. Timmons asked the witnesses if they agreed that there was a conflict of interest in working with international climate groups on financial regulations. Bashur said there is a potential that these groups have politically motivated funding sources that could politicize the regulatory review process. Williams asked about the consequences of the politicization of the Federal Reserve. Bashur said that the Fed is more interested in becoming a climate regulator and not a financial regulator. Bashur warned that new regulations are adding risk assessments based on climate risk, and Congress needs to address this before banks become utilities.

 

China & Russia Potential for Deceptive Engagement in the Basel Committee

Rose asked how Congress can be sure that China is not playing an outsized role in the international financial system regulations. Bashur said that Congress should be utilizing the IMF peer reviews required under Basel and that there is currently not enough information available about what China is involved in at these international forums.

 

Norman asked how Congress can mitigate the risk of Russia and China creating U.S. banking regulations. Bashur said that there must be publicly available notes and minutes of what is discussed in Basel Committee meetings so Congress can see which countries are proposing specific regulations.

 

Rep. Andy Ogles (R-Tenn.) asked whether China could use international banking forums to harm the U.S. financial system. Hoenig said that there is a risk because the U.S. could agree to follow the Basel protocols and China says they will oblige, but they never do. Skinner told the committee that the U.S. has no idea who is making these regulations, so it is impossible to say. He said that the existence of Chinese corporate espionage suggests that it is reasonable to say China could harm the U.S. financial system. Bashur said if China is on the Basel Board it is possible, they can harm the U.S. economy.

 

 

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