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A Holistic Review of Regulators: Regulatory Overreach and Economic Consequences

House Committee on Financial Services
Subcommittee on Financial Institutions and Monetary Policy
A Holistic Review of Regulators: Regulatory Overreach and Economic Consequences
Tuesday, September 19, 2023

Topline

  • Republicans voiced concerns over the impact of Basel III and Vice Chair Michael S. Barr’s capital requirements for banks.
  • Members from both parties expressed unease over the impact of recently proposed regulations on the availability and cost of credit.

Witnesses

  • Hal S. Scott, Emeritus Nomura Professor, International Financial Systems, Harvard Law School
  • Karen Petrou, Co-Founder and Managing Partner, Federal Financial Analytics Inc.
  • Margaret E. Tahyar, Partner, Davis Polk & Wardwell LLP
  • Mayra Rodríguez Valladares, Managing Principal, MRV Associates

Opening Statements
Subcommittee Chairman Andy Barr (R-Ky.)
In his opening statement, Barr explained that the Basel III-related proposal was incorrectly pushed as a response to the March 2023 banking crisis, adding that it has been delivered in an underdeveloped and hurried fashion. He emphasized that U.S. banks are well capitalized and resilient. Barr warned that Congress and the American people have been left out of the information flow, noting that members of Congress from both parties have requested analysis of the Basel-related capital proposal and have been ignored. He alleged clear violations of the Administrative Procedures Act. Barr noted that the capital requirements proposal contains a repeal by rule-writing of the bipartisan S.2155 tailoring law, which he said was done for partisan reasons. Barr concluded that the proposed rules threaten the financial system as a whole and will result in a loss of American competitiveness in banking and finance, causing jobs and economic activity to move overseas.

Subcommittee Ranking Member Bill Foster (D-Ill.)
In his opening statement, Foster said everyone needs to recognize that bank capital requirements and regulations will never be an exact science. He noted that the concerns voiced by Rep. Barr regarding the proposal were similar to those concerns voiced about the Dodd-Frank Act before it was enacted. Foster noted the decade after Dodd-Frank’s enactment was a very good decade for U.S. banks, especially the largest ones. He concluded that asking a bank to control its risks has material benefits throughout the economy, pointing to the last decade as proof.

Full Committee Ranking Member Maxine Waters (D-Calif.)
In her opening statement, Waters criticized Republicans for attacking regulators for developing policy proposals that would strengthen the banking system. She noted that Republicans are focusing exclusively on how proposed changes will impact Wall Street rather than the consumers who must pay for bank failures. Waters concluded that regulators must strengthen critical banking rules to protect consumers.

Testimony
Hal S. Scott, Emeritus Nomura Professor, International Financial Systems, Harvard Law School
In his testimony, Scott outlined three key reasons why U.S. bank regulators should not increase bank capital requirements at this time.

  • First, there is no need for a capital increase to maintain the stability of the banking system, as U.S. bank capital levels are strong.
  • Second, raising bank capital requirements would result in significant economic costs. Extensive empirical evidence has shown that increasing capital requirements reduces banks’ lending and capital markets activities, increases borrowing costs for businesses and consumers, and slows economic growth.
  • Third, raising bank capital requirements at this time could reduce the precision of the Fed’s monetary policy, thereby interfering with the Fed’s ongoing efforts to fight inflation. Scott explained that in the U.S., capital markets activities have a much larger role in financing the economy compared to other countries, who rely more on bank loans.

Scott concluded that the capital proposal would significantly increase U.S. bank capital requirements without a compelling policy rationale, adding that the failure of U.S. regulators to make adjustments will put the U.S. economy on an unequal competitive footing.

Karen Petrou, Co-Founder and Managing Partner, Federal Financial Analytics Inc.
In her testimony, Petrou called for “holistic” analysis of the proposed capital requirements by looking at their impact on the broader financial system as well as their cumulative impact on customers, financial stability, and shared and sustained growth. She criticized the use of tougher rules founded upon thousands of micro-managing pages, rather than rules founded on Prompt Corrective Action (PCA) as recommended by the General Accountability Office in 2011 and again this year. PCA would require federal banking regulators to take immediate action to identify and promptly address capital deficiencies at institutions.

She explained the proposed rules look at banks as static entities under simplistic scenarios that have significant analytical problems. Petrou criticized investors for not paying attention to non-bank financial intermediation while developing the proposals. She added that none of the pending rules consider the broader cumulative regulatory-impact analyses, noting that they may not harm credit availability in the aggregate, but will impact the distribution and accessibility of debt financing. Petrou concluded that each of these proposed rules undermine safety and soundness to the extent to which they encourage rapid migration of key activities outside of the regulatory perimeter.

Margaret E. Tahyar, Partner, Davis Polk & Wardwell LLP
In her testimony, Tahyar warned that the future role and structure of the American banking and financial sector is at stake. She explained that reforms should be targeted to achieve the right policy goals with as much regulatory efficiency as possible. Tahyar said the immensely complex proposals, which could radically change the U.S. financial sector, should not be rushed into place because of political timelines. She cautioned that no experts in any field fully understands the interrelationships of the proposed rules how they might impact credit extension, capital formation, the U.S. economy, or the role of the U.S. dollar.

Tahyar outlined the three most important concerns about the impacts of the many proposals:

  • First, what the proposed rules might collectively do to the competitive position of the U.S. globally systemic banks.
  • Second, how the proposed rules could generate so much pressure on regional banks that the structure of the U.S. banking sector is permanently changed; and
  • Third, how those rules might impact the scope of the U.S. banking sector.

She warned that the operational risk requirements of the Basel III endgame would be significant and would disproportionately affect U.S. banks. Tahyar noted that Congress should be concerned with the fact that there are two different living wills regimes under two different statutory authorities with different requirements, consequences, timings, and standards. She concluded that there are too many proposals under consideration at the same time with too many unintended consequences for the U.S. economy and the financial sector. She explained that it is unreasonable to think that there is enough time for Congress to engage in effective oversight and for the private sector and public advocates to seriously engage.

Mayra Rodríguez Valladares, Managing Principal, MRV Associates
In her testimony, Valladares warned that financial instability often follows periods when financial institutions, like investors and policy makers, have underestimated risks. She noted that since 2010, which marks the beginning of the design and incremental implementation of Basel III and Dodd-Frank rules, U.S. banking assets have almost doubled. Valladares said that during the same period, U.S. banks’ net income rose by 225%, and banks increased dividend payouts to record highs. She asked lawmakers to imagine how much more capitalized U.S. banks would be if in the last twenty-three years, their misdeeds had not cost them over a quarter of a trillion dollars in fines. She noted that banks generated fines rather than maintained adequate liquidity buffers to maintain systemic safety and lend to businesses and consumers.

Valladares explained that U.S. banks were resilient between 2020 through February 2023 even while being impacted during the unprecedented economic stress brought on by COVID-19. She noted Basel III and Dodd-Frank’s capital, liquidity, stress test, and living will requirements were critical in helping banks succeed in surviving unexpected losses. Valladares warned that Banks are being impacted by a myriad of risks, including the elevated interest rate environment, rising defaults in some consumer and corporate sectors, cybersecurity, climate change, rising civil unrest domestically, and geopolitical threats.

She said these risks are barely covered if at all, by the so-called Basel III Endgame or the capital or liquidity stress tests required by Title I of the Dodd-Frank Act.

Valladares concluded that by updating changes to Basel III and Dodd-Frank, U.S. bank regulators are fulfilling their mission of ensuring the safety and soundness of the American banking system. She explained that most large banks can meet the updated capital requirements, and those that cannot are fully capable of shedding risky assets to be well-capitalized and liquid. Valladares emphasized that under no circumstances should the proposed capital and bank resolution rules be withdrawn.

Question & Answer
Capital Requirements

Barr asked if Fed Vice Chair Barr’s capital requirements proposal would give borrowers a harder time shopping for loans, as banks that would be subject to these rules may make similar choices on availability and pricing on loan types. Tahyar said yes, explaining the loan types that will be most impacted are non-listed private companies and certain mortgages with lower downpayments. Barr asked if this decreases systemic resiliency, and Tahyar said yes, noting it’s also an issue for bank profitability.

Rep. Roger Williams (R-Texas) asked if Silicon Valley Bank failed because it was not subject to one-size-fits-all capital requirements. Petrou said no, explaining that banking agencies had extensive discretion under S. 2155 (Economic Growth, Regulatory Relief, and Consumer Protection Act) to set standards. She clarified that the problem was supervision, not tailoring.

Rep. Ayanna Pressley (D-Mass.) said Republicans rolled back aspects of Dodd-Frank in 2018, resulting in financial collapses like the SVB failure. Pressley asked if SVB was allowed to opt out of capital requirements relating to Accumulated Other Comprehensive Income (AOCI) because of the 2018 Republican deregulation bill. Valladares said S. 2155 was incredibly detrimental, explaining SVB-size banks must be considered domestically important and need to be better supervised.

Pressley said the response to recent financial collapses must resemble how Congress reacted after the 2008 crisis and called for stronger capital requirements.

Credit Availability
Rep. Bill Posey (R-Fla.) asked about the cumulative impacts on credit availability resulting from the Biden Administration’s surge in bank regulations. Scott said the regulatory agencies should do that analysis, noting a complete analysis should be required for each proposed rule.

Rep. Joyce Beatty (D-Ohio) asked how the capital proposal will impact small businesses and the cost and availability of credit. Valladares said the updated rules should not lead to a decrease in lending. She explained that empirical data shows that better capitalized banks are safer, and their cost of borrowing goes down.

Williams asked how the Basel III endgame proposal will impact lending and the cost of credit for borrowers.  Scott said it will increase costs for banks, resulting in higher costs for borrowers and consumers.

Rep. Monica De La Cruz (R-Texas) asked if Scott agreed or disagreed with Ms. Valladares’ statement that raising capital requirements will not decrease bank lending. Scott disagreed, noting higher capital decreases lending, and the question is by how much will lending decrease.

Rep. Young Kim (R-Calif.) said she is deeply concerned that the Basel III endgame and other proposals would make credit more expensive for small businesses. She said they will reduce lending for low-to-moderate income households and put our banks at a competitive disadvantage internationally.

Basel III
Barr asked if Basel III’s impact on capital markets would be more significant in the U.S., particularly given the additional layer of rulemaking issued by the SEC. Scott said it will have a very severe impact on capital markets here because our economy is very different than the rest of the world, citing the importance of companies to finance themselves through capital markets. He explained that when you combine the capital impact with the 47 substantive rulemakings of the SEC impacting the capital markets, our crown jewel, our capital markets, are in danger.

Rep. Scott Fitzgerald (R-Wisc.) asked why the Basel standard is poorly suited for smaller banks. Petrou said it will be extremely difficult for smaller banks because of the operational and risk requirements. She explained that smaller banks will be holding an unnecessary amount of capital that could otherwise go to lending for underserved borrowers.

Kim asked how the changes to operational risk could put U.S. banks at a competitive disadvantage with banks headquartered in Asia and Europe. Tahyar said the impact will be mostly on global systemically important banks (G-SIBs) that operate internationally and are in direct competition with their European and Asian peers. She noted Chinese banks will never be subject to a similar set of rules and European banks have a fundamentally business model. She said it was unclear why why the U.S. is trying to hobble its competitive banking sector.

Rep. Andy Ogles (R-Tenn.) said one size fits all solutions are problematic and asked Scott about his primary concern with Basel III.  Scott said we need to consider all costs and benefits, adding regulators are not looking at interest rate risk. He emphasized the need for a much better analytical evaluation of the proposals.

Rep. William Timmons (R-S.C.) said he is particularly concerned with how Basel III capital requirements will exacerbate the strain on bank capital availability and called for real-world modeling.

 

For more information on this meeting, please click here.
For an archive of past SIFMA hearing coverage, please click here.