House Financial Services on More Capital or More Government Control
“Making a Financial Choice: More Capital or More Government Control?”
Key Topics & Takeaways
- Risk Weighted Capital Vs. Leverage Ratio:Rep. Carolyn Maloney (D-N.Y.) recalled that the risk-weighted capital requirements did not accurately depict the risk of certain assets (such as mortgage securities) in the lead up to the financial crisis. However, she argued that the leverage ratio is an even less accurate indicator of the riskiness of underlying assets. TCH’s Jeremy Newell agreed that the solution should be to improve the accuracy of the risk-based capital regime, rather than rely on a blunt instrument such as the leverage ratio. The R Street Institute’s Alex Pollock argued that the risk-weighted capital regime can lead to more systemic risk, since regulators do not have foresight about future sources of instability and failed to prevent the financial crisis in 2008.
- Repeal of Orderly Liquidation Authority:Rep. Carolyn Maloney (D-N.Y.) cautioned against the Financial CHOICE Act’s repeal of the OrderlyLiquidation Authority (OLA), which she said would leave the financial system “dangerously exposed” to future bank failure. Newell agreed that OLA is an important tool for financial stability and repealing that authority would make the financial system “less safe.” However, Rep. Andy Barr (R-Ky.) maintained that OLA gives larger financial institutions a “funding advantage” and creates the perception of “too big to fail.”
Speakers
- John Allison, Former President and Chief Executive Officer, Cato Institute
- Jim Nussle, President and Chief Executive Officer, Credit Union National Association
- Adam Levitin, Professor of Law, Georgetown University Law Center
- Alex J. Pollock, Distinguished Senior Fellow, R Street Institute
- Jeremy Newell, Executive Managing Director, Head of Regulatory Affairs and General Counsel, The Clearing House Association LLC
- Jim Purcell, Chairman, State National Bank of Big Spring and Chairman, Texas Bankers Association
Opening Remarks
Jeb Hensarling (R-Texas), Committee Chairman
Hensarling maintained that stagnant economic growth is the result of the Dodd-Frank Act, which he said has “hurt the economy, hurt consumers, codified bank bailouts, and made [the] financial system less stable.” Hensarling referred to his Financial CHOICE Act as a “new paradigm in banking and capital markets” which he said will “relieve financial institutions from growth strangling regulations that create more economic burden than benefit in exchange for voluntarily meeting higher, yet simpler, capital requirements.” He explained that the CHOICE Act relies solely on the leverage ratio as an indicator for capital adequacy, “rather than the discredited risk-based capital regime.” Hensarling concluded that the off-rampprovided in his bill would help create a “healthier economy for all struggling Americans.”
Maxine Waters (D-Calif.), Committee Ranking Member
In her opening remarks, Waters spoke out against the Financial CHOICE Act, which she characterized as a “piecemeal” attempt to “undercut Wall Street reform.” She claimed that the bill is part of a “massive deregulatory agenda” that forwards special interests instead of building a healthier economy. Waters maintained that the “Wrong CHOICE Act” is not a “serious” financial reform proposal since it would do nothing to “shrink megafirms” and would provide large financial institutions with an implicit government guarantee. She criticized the Financial CHOICE Act as “the wrong choice for consumers, investors, and the entire financial system” and she called instead for policymakers to focus on ensuring that the Dodd-Frank Act is implemented effectively and efficiently.
Panel Testimony
John Allison, Former President and Chief Executive Officer, Cato Institute
In his testimony, Allison argued that the Federal Reserve’s (Fed’s) regulations and policy were a “major contributor to the crisis.” He argued that the Fed’s policies result in misallocations of capital, relying too much on Basel III capital standards, and regulating an entire industry instead of only the unhealthy banks. Reflecting on his decades of experience leading BB&T, Allison recalled that he led the bank through previous crises by continuing lending activities during unstable times. According to Allison, however, the Fed prevented banks from lending during and in the aftermath of the 2008 crisis. He also criticized the Fed for halting venture capital lending, which he claimed resulted in “slowing growth in the economy and lowering the standard of living for the average consumer.”
Allison maintained that “the biggest determinant of a bank’s health is its capital position” and expressed support for a simple leverage ratio instead of the risk-weighted capital regime. He added that the off-ramp provided in the Financial CHOICE Act would create “market pressure to get a rational banking size,” whereby bankers will have to manage capital standards and get rid of unprofitable businesses (resulting in smaller firms).Allison concluded that banks play a “critical role of helping businesses get started” and grow, and agreed that higher capital standards and less regulation would improve financial stability and economic growth.
Jim Nussle, President and Chief Executive Officer, Credit Union National Association
Nussle explained that credit unions are being “crushed” by the regulatory burden from the Dodd-Frank Act, which he said has resulted in reduced availability of credit and the consolidation of the industry. He expressed support for the regulatory relief provisions in the Financial CHOICE Act, noting that about 65 percent of all credit unions already maintain a leverage ratio in excess of 10 percent. Nussle concluded by stating that he believes that many credit unions would take advantage of regulatory relief offered under the bill.
Adam Levitin, Professor of Law, Georgetown University Law Center
Levitin maintained that deregulation provisions in the Financial CHOICE Act would eliminate key prudential regulations for all firms irrespective of their capital levels. He claimed that the bill virtually “eliminates” consumer financial protection, significantly limits the Securities and Exchange Commission’s (SEC’s) powers, replaces Orderly Liquidation Authority (OLA) with an “unworkable” bankruptcy regime, and would subject federal regulators to “constant political interference” and “Congressional micromanagement.”
Levitin contended that there is “no basis” for the 10 percent leverage ratio, which he characterized as “grossly irresponsible.” Further, he argued that “megabanks” get a “much better deal under the CHOICE Act” than community banks do, as well as that solely relying on the leverage ratio is “not healthy in the long run” and would induce risky bank behavior. Levitin claimed that the minimum capital standard must be combined with other prudential measures including liquidity and concentration limits, without which, he said, the Financial CHOICE Act is a “recipe for financial disaster.”
Alex J. Pollock, Distinguished Senior Fellow, R Street Institute
Pollock argued that “detailed, intrusive regulation is doomed to fail” because nobody knows enough about the future to prevent emergent systemic risks. He expressed support for the Financial CHOICE Act, since he claimed that greater bank equity capital provides less rationale for “intrusive and onerous regulation.” Pollock maintained that the bill offers banks “a very logical decision” between more regulation and more capital, and claimed that the simple leverage ratio is superior to the complex, risk-based capital regime which he characterized as rules based on “bureaucratic compromises” rather than based on empirical evidence.
Jeremy Newell, Executive Managing Director, Head of Regulatory Affairs and General Counsel, The Clearing House Association LLC
Newell explained that the quantity and quality of capital held by banks have increased substantially under the current reform agenda. As evidence, he pointed to the recent Comprehensive Capital Analysis and Review (CCAR) stress test results whereby all of the 33 banks demonstrated that they can maintain their capital buffers during a severe stress scenario. Newell acknowledged that the Financial CHOICE Act includes several good ideas but cautioned about relying on the Supplementary Leverage Ratio, which he said is an “inaccurate” measure of risk since it treats all assets as the same. Newell suggested that the Financial CHOICE Act’s reliance on the Supplementary Leverage Ratio be “reconsidered” since it “is almost always wrong.”
Jim Purcell, Chairman, State National Bank of Big Spring and Chairman, Texas Bankers Association
In his testimony, Purcell noted the decline in community bank presence in Texas since 2010, which he said were driven in part by regulatory burden from the Dodd-Frank Act. Purcell expressed his support for the Financial CHOICE Act, which he said should allow regulators to tailor rules to banks’ business models rather than imposing the one-size-fits-all approach currently in place.
Questions and Answers
Capital, Stability and Economic Growth
In response to a question from Hensarling regarding whether high levels of government intrusion or high levels of equity capital will maximize economic growth, Allison maintained that the Dodd-Frank Act has caused bankers to “focus on the wrong thing” by forcing them to comply with rules instead of helping their clients grow their businesses. Allison claimed that banks cannot be properly capitalized and afford the regulatory costs under the Dodd-Frank Act, and argued that there would be no need for taxpayer bailouts if banks had robust capital buffers.
Effectiveness of CHOICE Act
Waters noted that supporters of the Financial CHOICE Act maintain that a simple leverage ratio is easier for regulators to enforce and less prone tomanipulation, yet she expressed doubt about the effectiveness of this approach in terms of improving safety and soundness. Levitin expressed concern about the effect of simplified capital requirements in Title I combined with other provisions in the bill, which he claimed would render regulators “completely ineffective.”
Bankruptcy Provisions
Levitin maintained that a bridge company must have access to “massive” amounts of financing in order for the bankruptcy process to be effective. However, he expressed doubt that private capital markets would be able to deliver the amount of financing necessary overnight when there is uncertainty or stress in the markets.
Big Banks Vs. Community Banks
In response to Garrett’s request for clarity on the provisions supported by The Clearing House, Newell explained that they support the core capital and liquidity reforms that have been enacted since the financial crisis, with the caveat that some aspects of the rules should be recalibrated or tailored to firms’ business models. From that, Garrett concluded that the largest banks benefit from the Dodd-Frank Act while smaller, community banks “pay the price.”
Rep. Nydia Velazquez (D-N.Y.) asked how the Financial CHOICE Act will help “megabanks” more than it will help community banks, to which Levitin responded that the bill will allow banks to opt out of Basel III as well as heightened prudential standards under the Dodd-Frank Act. He suggested limiting the off-ramp in Title I only to community banks to resolve this issue.
Orderly Liquidation Authority
Rep. Carolyn Maloney (D-N.Y.) noted that the Financial CHOICE Act would repeal Orderly Liquidation Authority (OLA), which she cautioned would leave the financial system “dangerously exposed” to future bank failure. Newell expressed support for Title II of the Dodd-Frank Act, stating that OLA is an important tool for financial stability and repealing that authority would make the financial system “less safe.” He added that the industry supports the enhanced bankruptcy provisions in the discussion draft of the bill, but reiterated that OLA is a necessary “backstop.”
Rep. Andy Barr (R-Ky.) maintained that OLA gives larger financial institutions a “funding advantage” and creates the perception of “too big to fail.” Barr concluded that the Dodd-Frank Act has helped large Wall Street banks and created an unlevel playing field for smaller community banks.
Impact on Litigation
Velazquez asked how the CHOICE Act would make it easier for regulated entities to challenge regulatory rules and bring litigation challenges against the Consumer Financial Protection Bureau (CFPB). Levitin explained that the bill overturns the Chevron Doctrine that requires courts to give deference to administrative agencies’ interpretation of the law. He added that the requirement to conduct cost-benefit analysis is not always “appropriate” and claimed that it, too, would make it easier for firms that do not “like regulation” to bring litigation against regulatory agencies.
Declining Number of Community Banks
Neugebauer expressed concern about the decline in community banks and asked whether the CHOICE Act would help reverse that trend. Purcell agreed that it would likely be helpful to start reversing that trend and improving access to finance for communities in Texas.
Leverage Ratio Rate
Rep. David Scott (D-Ga.) expressed concern that the CHOICE Act could undermine financial stability. He characterized the bill as a “dangerous,” “overzealous” attempt for banks to avoid being regulated by the Federal Reserve, and he argued that the “arbitrary” 10 percent leverage ratio may be prone to manipulation. Levitin agreed that the 10 percent leverage ratio has “absolutely no basis.”
Rep. Huizenga (R-Mich.) cited data from the Federal Deposit Insurance Corporation, which he said indicated that 90% of insured depository institutions with a minimum 10 percent leverage ratio weathered the storm of the financial crisis. Pollock agreed and pointed to analysis from the International Monetary Fund that concluded that a 9.5 percent leverage ratio would have prevented creditor losses during the financial crisis.
Risk Weighted Capital Vs. Leverage Ratio
Rep. Carolyn Maloney (D-N.Y.) recalled the key problem with the risk-weighted capital requirements, that they did not accurately depict the risk of certain assets (such as mortgage securities) in the lead up to the financial crisis. However, she argued that the leverage ratio is an even less accurate indicator of the riskiness of underlying assets. Newell agreed that the solution should be to improve the accuracy of the risk-based capital regime, rather than rely on a blunt instrument such as the leverage ratio.
Pollock argued that the risk-weighted capital regime can lead to more systemic risk, since regulators do not have foresight about future sources of instability and failed to prevent the financial crisis in 2008.
Rep. Dennis Ross (R-Fla.) also expressed concern that regulators were “asleep at the switch” in the lead up to the financial crisis, and that the current regulatory regime is predicated on the notion that regulators will be able to foretell systemic risks.
Unintended Consequences of Leverage Ratio
In response to Maloney’s question, Newell cautioned that use of the leverage ratio as a primary measure of bank capital would encourage banks to hold less low-risk assets and instead increase their holdings of risky assets.
Basel IV
Rep. Royce (R-Calif.) expressed concern that foreign regulators (such as the Basel Committee) are developing new capital standards that are expected to be adopted in the U.S., but the Federal Reserve has not set out an advanced notice of proposed rulemaking, provided other opportunities for public comment, or published cost-benefit analyses.
Regulatory Simplification
Rep. Ann Wagner (R-MO) noted that the EU is examining how the post-crisis regulatory reforms could be simplified to enhance economic growth through the Call for Evidence. When asked how simplification helps make the financial system safer and boosts economic growth, Allison explained that simplification will allow financial institutions to spend less time on regulatory compliance and instead focus more on growing their businesses to serve the needs of the real economy.
Repeal of Volcker Rule
Rep. David Scott (D-Ga.) cautioned against repealing the Volcker Rule to ensure customers’ deposits cannot be used to make “risky bets.” In contrast, Rep. Mia Love (R-Utah) maintained that the Volcker Rule has been a “solution in search of a problem” and has undermined financial stability rather than improving it. Pollock clarified that he does not think repeal of the Volcker Rule will undermine financial stability, since he said the rule had “nothing to do” with the drivers of the financial crisis.
Additional information about this event can be accessed here.
“Making a Financial Choice: More Capital or More Government Control?”
Key Topics & Takeaways
- Risk Weighted Capital Vs. Leverage Ratio:Rep. Carolyn Maloney (D-N.Y.) recalled that the risk-weighted capital requirements did not accurately depict the risk of certain assets (such as mortgage securities) in the lead up to the financial crisis. However, she argued that the leverage ratio is an even less accurate indicator of the riskiness of underlying assets. TCH’s Jeremy Newell agreed that the solution should be to improve the accuracy of the risk-based capital regime, rather than rely on a blunt instrument such as the leverage ratio. The R Street Institute’s Alex Pollock argued that the risk-weighted capital regime can lead to more systemic risk, since regulators do not have foresight about future sources of instability and failed to prevent the financial crisis in 2008.
- Repeal of Orderly Liquidation Authority:Rep. Carolyn Maloney (D-N.Y.) cautioned against the Financial CHOICE Act’s repeal of the OrderlyLiquidation Authority (OLA), which she said would leave the financial system “dangerously exposed” to future bank failure. Newell agreed that OLA is an important tool for financial stability and repealing that authority would make the financial system “less safe.” However, Rep. Andy Barr (R-Ky.) maintained that OLA gives larger financial institutions a “funding advantage” and creates the perception of “too big to fail.”
Speakers
- John Allison, Former President and Chief Executive Officer, Cato Institute
- Jim Nussle, President and Chief Executive Officer, Credit Union National Association
- Adam Levitin, Professor of Law, Georgetown University Law Center
- Alex J. Pollock, Distinguished Senior Fellow, R Street Institute
- Jeremy Newell, Executive Managing Director, Head of Regulatory Affairs and General Counsel, The Clearing House Association LLC
- Jim Purcell, Chairman, State National Bank of Big Spring and Chairman, Texas Bankers Association
Opening Remarks
Jeb Hensarling (R-Texas), Committee Chairman
Hensarling maintained that stagnant economic growth is the result of the Dodd-Frank Act, which he said has “hurt the economy, hurt consumers, codified bank bailouts, and made [the] financial system less stable.” Hensarling referred to his Financial CHOICE Act as a “new paradigm in banking and capital markets” which he said will “relieve financial institutions from growth strangling regulations that create more economic burden than benefit in exchange for voluntarily meeting higher, yet simpler, capital requirements.” He explained that the CHOICE Act relies solely on the leverage ratio as an indicator for capital adequacy, “rather than the discredited risk-based capital regime.” Hensarling concluded that the off-rampprovided in his bill would help create a “healthier economy for all struggling Americans.”
Maxine Waters (D-Calif.), Committee Ranking Member
In her opening remarks, Waters spoke out against the Financial CHOICE Act, which she characterized as a “piecemeal” attempt to “undercut Wall Street reform.” She claimed that the bill is part of a “massive deregulatory agenda” that forwards special interests instead of building a healthier economy. Waters maintained that the “Wrong CHOICE Act” is not a “serious” financial reform proposal since it would do nothing to “shrink megafirms” and would provide large financial institutions with an implicit government guarantee. She criticized the Financial CHOICE Act as “the wrong choice for consumers, investors, and the entire financial system” and she called instead for policymakers to focus on ensuring that the Dodd-Frank Act is implemented effectively and efficiently.
Panel Testimony
John Allison, Former President and Chief Executive Officer, Cato Institute
In his testimony, Allison argued that the Federal Reserve’s (Fed’s) regulations and policy were a “major contributor to the crisis.” He argued that the Fed’s policies result in misallocations of capital, relying too much on Basel III capital standards, and regulating an entire industry instead of only the unhealthy banks. Reflecting on his decades of experience leading BB&T, Allison recalled that he led the bank through previous crises by continuing lending activities during unstable times. According to Allison, however, the Fed prevented banks from lending during and in the aftermath of the 2008 crisis. He also criticized the Fed for halting venture capital lending, which he claimed resulted in “slowing growth in the economy and lowering the standard of living for the average consumer.”
Allison maintained that “the biggest determinant of a bank’s health is its capital position” and expressed support for a simple leverage ratio instead of the risk-weighted capital regime. He added that the off-ramp provided in the Financial CHOICE Act would create “market pressure to get a rational banking size,” whereby bankers will have to manage capital standards and get rid of unprofitable businesses (resulting in smaller firms).Allison concluded that banks play a “critical role of helping businesses get started” and grow, and agreed that higher capital standards and less regulation would improve financial stability and economic growth.
Jim Nussle, President and Chief Executive Officer, Credit Union National Association
Nussle explained that credit unions are being “crushed” by the regulatory burden from the Dodd-Frank Act, which he said has resulted in reduced availability of credit and the consolidation of the industry. He expressed support for the regulatory relief provisions in the Financial CHOICE Act, noting that about 65 percent of all credit unions already maintain a leverage ratio in excess of 10 percent. Nussle concluded by stating that he believes that many credit unions would take advantage of regulatory relief offered under the bill.
Adam Levitin, Professor of Law, Georgetown University Law Center
Levitin maintained that deregulation provisions in the Financial CHOICE Act would eliminate key prudential regulations for all firms irrespective of their capital levels. He claimed that the bill virtually “eliminates” consumer financial protection, significantly limits the Securities and Exchange Commission’s (SEC’s) powers, replaces Orderly Liquidation Authority (OLA) with an “unworkable” bankruptcy regime, and would subject federal regulators to “constant political interference” and “Congressional micromanagement.”
Levitin contended that there is “no basis” for the 10 percent leverage ratio, which he characterized as “grossly irresponsible.” Further, he argued that “megabanks” get a “much better deal under the CHOICE Act” than community banks do, as well as that solely relying on the leverage ratio is “not healthy in the long run” and would induce risky bank behavior. Levitin claimed that the minimum capital standard must be combined with other prudential measures including liquidity and concentration limits, without which, he said, the Financial CHOICE Act is a “recipe for financial disaster.”
Alex J. Pollock, Distinguished Senior Fellow, R Street Institute
Pollock argued that “detailed, intrusive regulation is doomed to fail” because nobody knows enough about the future to prevent emergent systemic risks. He expressed support for the Financial CHOICE Act, since he claimed that greater bank equity capital provides less rationale for “intrusive and onerous regulation.” Pollock maintained that the bill offers banks “a very logical decision” between more regulation and more capital, and claimed that the simple leverage ratio is superior to the complex, risk-based capital regime which he characterized as rules based on “bureaucratic compromises” rather than based on empirical evidence.
Jeremy Newell, Executive Managing Director, Head of Regulatory Affairs and General Counsel, The Clearing House Association LLC
Newell explained that the quantity and quality of capital held by banks have increased substantially under the current reform agenda. As evidence, he pointed to the recent Comprehensive Capital Analysis and Review (CCAR) stress test results whereby all of the 33 banks demonstrated that they can maintain their capital buffers during a severe stress scenario. Newell acknowledged that the Financial CHOICE Act includes several good ideas but cautioned about relying on the Supplementary Leverage Ratio, which he said is an “inaccurate” measure of risk since it treats all assets as the same. Newell suggested that the Financial CHOICE Act’s reliance on the Supplementary Leverage Ratio be “reconsidered” since it “is almost always wrong.”
Jim Purcell, Chairman, State National Bank of Big Spring and Chairman, Texas Bankers Association
In his testimony, Purcell noted the decline in community bank presence in Texas since 2010, which he said were driven in part by regulatory burden from the Dodd-Frank Act. Purcell expressed his support for the Financial CHOICE Act, which he said should allow regulators to tailor rules to banks’ business models rather than imposing the one-size-fits-all approach currently in place.
Questions and Answers
Capital, Stability and Economic Growth
In response to a question from Hensarling regarding whether high levels of government intrusion or high levels of equity capital will maximize economic growth, Allison maintained that the Dodd-Frank Act has caused bankers to “focus on the wrong thing” by forcing them to comply with rules instead of helping their clients grow their businesses. Allison claimed that banks cannot be properly capitalized and afford the regulatory costs under the Dodd-Frank Act, and argued that there would be no need for taxpayer bailouts if banks had robust capital buffers.
Effectiveness of CHOICE Act
Waters noted that supporters of the Financial CHOICE Act maintain that a simple leverage ratio is easier for regulators to enforce and less prone tomanipulation, yet she expressed doubt about the effectiveness of this approach in terms of improving safety and soundness. Levitin expressed concern about the effect of simplified capital requirements in Title I combined with other provisions in the bill, which he claimed would render regulators “completely ineffective.”
Bankruptcy Provisions
Levitin maintained that a bridge company must have access to “massive” amounts of financing in order for the bankruptcy process to be effective. However, he expressed doubt that private capital markets would be able to deliver the amount of financing necessary overnight when there is uncertainty or stress in the markets.
Big Banks Vs. Community Banks
In response to Garrett’s request for clarity on the provisions supported by The Clearing House, Newell explained that they support the core capital and liquidity reforms that have been enacted since the financial crisis, with the caveat that some aspects of the rules should be recalibrated or tailored to firms’ business models. From that, Garrett concluded that the largest banks benefit from the Dodd-Frank Act while smaller, community banks “pay the price.”
Rep. Nydia Velazquez (D-N.Y.) asked how the Financial CHOICE Act will help “megabanks” more than it will help community banks, to which Levitin responded that the bill will allow banks to opt out of Basel III as well as heightened prudential standards under the Dodd-Frank Act. He suggested limiting the off-ramp in Title I only to community banks to resolve this issue.
Orderly Liquidation Authority
Rep. Carolyn Maloney (D-N.Y.) noted that the Financial CHOICE Act would repeal Orderly Liquidation Authority (OLA), which she cautioned would leave the financial system “dangerously exposed” to future bank failure. Newell expressed support for Title II of the Dodd-Frank Act, stating that OLA is an important tool for financial stability and repealing that authority would make the financial system “less safe.” He added that the industry supports the enhanced bankruptcy provisions in the discussion draft of the bill, but reiterated that OLA is a necessary “backstop.”
Rep. Andy Barr (R-Ky.) maintained that OLA gives larger financial institutions a “funding advantage” and creates the perception of “too big to fail.” Barr concluded that the Dodd-Frank Act has helped large Wall Street banks and created an unlevel playing field for smaller community banks.
Impact on Litigation
Velazquez asked how the CHOICE Act would make it easier for regulated entities to challenge regulatory rules and bring litigation challenges against the Consumer Financial Protection Bureau (CFPB). Levitin explained that the bill overturns the Chevron Doctrine that requires courts to give deference to administrative agencies’ interpretation of the law. He added that the requirement to conduct cost-benefit analysis is not always “appropriate” and claimed that it, too, would make it easier for firms that do not “like regulation” to bring litigation against regulatory agencies.
Declining Number of Community Banks
Neugebauer expressed concern about the decline in community banks and asked whether the CHOICE Act would help reverse that trend. Purcell agreed that it would likely be helpful to start reversing that trend and improving access to finance for communities in Texas.
Leverage Ratio Rate
Rep. David Scott (D-Ga.) expressed concern that the CHOICE Act could undermine financial stability. He characterized the bill as a “dangerous,” “overzealous” attempt for banks to avoid being regulated by the Federal Reserve, and he argued that the “arbitrary” 10 percent leverage ratio may be prone to manipulation. Levitin agreed that the 10 percent leverage ratio has “absolutely no basis.”
Rep. Huizenga (R-Mich.) cited data from the Federal Deposit Insurance Corporation, which he said indicated that 90% of insured depository institutions with a minimum 10 percent leverage ratio weathered the storm of the financial crisis. Pollock agreed and pointed to analysis from the International Monetary Fund that concluded that a 9.5 percent leverage ratio would have prevented creditor losses during the financial crisis.
Risk Weighted Capital Vs. Leverage Ratio
Rep. Carolyn Maloney (D-N.Y.) recalled the key problem with the risk-weighted capital requirements, that they did not accurately depict the risk of certain assets (such as mortgage securities) in the lead up to the financial crisis. However, she argued that the leverage ratio is an even less accurate indicator of the riskiness of underlying assets. Newell agreed that the solution should be to improve the accuracy of the risk-based capital regime, rather than rely on a blunt instrument such as the leverage ratio.
Pollock argued that the risk-weighted capital regime can lead to more systemic risk, since regulators do not have foresight about future sources of instability and failed to prevent the financial crisis in 2008.
Rep. Dennis Ross (R-Fla.) also expressed concern that regulators were “asleep at the switch” in the lead up to the financial crisis, and that the current regulatory regime is predicated on the notion that regulators will be able to foretell systemic risks.
Unintended Consequences of Leverage Ratio
In response to Maloney’s question, Newell cautioned that use of the leverage ratio as a primary measure of bank capital would encourage banks to hold less low-risk assets and instead increase their holdings of risky assets.
Basel IV
Rep. Royce (R-Calif.) expressed concern that foreign regulators (such as the Basel Committee) are developing new capital standards that are expected to be adopted in the U.S., but the Federal Reserve has not set out an advanced notice of proposed rulemaking, provided other opportunities for public comment, or published cost-benefit analyses.
Regulatory Simplification
Rep. Ann Wagner (R-MO) noted that the EU is examining how the post-crisis regulatory reforms could be simplified to enhance economic growth through the Call for Evidence. When asked how simplification helps make the financial system safer and boosts economic growth, Allison explained that simplification will allow financial institutions to spend less time on regulatory compliance and instead focus more on growing their businesses to serve the needs of the real economy.
Repeal of Volcker Rule
Rep. David Scott (D-Ga.) cautioned against repealing the Volcker Rule to ensure customers’ deposits cannot be used to make “risky bets.” In contrast, Rep. Mia Love (R-Utah) maintained that the Volcker Rule has been a “solution in search of a problem” and has undermined financial stability rather than improving it. Pollock clarified that he does not think repeal of the Volcker Rule will undermine financial stability, since he said the rule had “nothing to do” with the drivers of the financial crisis.
Additional information about this event can be accessed here.