Senate Banking Subcommittee Discusses Limiting Federal Support for Financial Firms
AT TODAY’S SENATE BANKING SUBCOMMITEE HEARING, lawmakers discussed the concentration of banking activities and the implications of such changes in the banking sector. The hearing consisted of three panels featuring former Federal Reserve Chairman Paul Volcker, Federal Deposit Insurance Corporation (FDIC) Board member Thomas Hoenig, Federal Reserve official Randall Kroszner, and a panel of industry representatives.
Subcommittee Chairman Sherrod Brown (D-Ohio) began the hearing by noting his intention of reintroducing the “SAFE Banking Act” which would impose a cap on any bank holding company’s share of the total insured deposits in the U.S. and would reduce the maximum amount of non-deposit liabilities at financial firms, among other things.
Testimony
In his opening statement, Paul Volcker noted that the greatest structural challenges facing the financial system is the perception of “too big to fail.” He said provisions in the Dodd-Frank Act deal with this issue, including the Volcker Rule. Volcker pointed to other issues that need to be addressed such as reform of the government sponsored enterprises (GSEs) and encouraging more private sector participation in housing finance activities, and reforming money market mutual funds (MMFs). Volcker noted how MMFs are vulnerable to runs in times of stress and said they need to be harnessed “in a manner that recognizes both their structural importance in diverting funds from regulated banks and their destabilizing potential.” He suggested MMFs be treated as ordinary mutual funds, “with redemption values reflecting day by day market price fluctuations.” Volcker also called for a member of the Federal Reserve to be designated as Vice Chairman for Supervision, a position that has not been filled nearly two years after its authorization.
Thomas Hoenig, FDIC Board member, submitted his paper “Restructuring the Banking System to Improve Safety and Soundness” from May 2011 as his statement for the record. The paper was written when Hoenig served as President and CEO of the Federal Reserve Bank of Kansas City and outlines proposals to “reintroduce accountability” by restricting bank activities.
Randall Kroszner, Member-Designate of the Federal Reserve Board, submitted his paper on “Stability, Growth and Regulatory Reform” from April 2012 as his statement for the record. The paper discusses the value of financial innovation and the effects regulatory reform efforts have on the financial system.
In his opening statement, Tom Frost, Chairman Emeritus of Frost National Bank, discussed how the banking business has evolved into two different cultures – one that is transactions-based and one that is based on customer relationships. He suggested these cultures be separated and that government support should not be given to hedging and speculative services.
In his opening statement, Marc Jarsulic, Chief Economist for Better Markets, Inc., discussed how high leverage , proprietary trading, and dependence on unstable short term financing made large financial firms vulnerable during the financial crisis. Jarsulic suggested the Volcker Rule place “meaningful leverage and liquidity requirements on bank broker dealers” and lower the permitted leverage. He also suggested the repo market be designated and supervised by the Financial Stability Oversight Council in order to enact effective regulation of the shadow banking system.
In his opening statement, James Roselle, Associate General Counsel for Northern Trust Corporation, highlighted specific provisions in the proposed Volcker Rule that may have negative impacts on firms that Congress did not intend for the rule to cover. Those concerns include “the overly broad definition of “covered fund” and the impact that so-called “Super 23A prohibitions will have on custody-related transactions; the proposed inclusion of foreign exchange swaps and forwards in the proprietary trading restrictions; and the unnecessary and onerous proposed compliance requirements.”
In his opening statement, Anthony Carfang, Partner at Treasury Strategies, Inc., who testified on behalf of the U.S. Chamber of Commerce, discussed regulatory reform provisions that may have negative effects on capital raising methods for businesses. Carfang noted that “artificial and arbitrary caps on the financial industry, or the Volcker Rule (as currently proposed), or additional money market regulation will not reduce systemic risk.” He said such regulation will force “non-financial companies that are the engines of our economy to retrench, enhance their cash positions and face a much tougher time raising the capital needed to operate, grow and create jobs.”
Panel I Q&A
Brown addressed the issue of moral hazard with regard to large financial institutions and asked Volcker what regulators can do to send the message to markets that such firms will not be propped up by the government if they get into trouble.
Volcker said provisions in Dodd-Frank will assist in the orderly liquidation of a large firm, including authorizing the FDIC with powers of conservatorship and requiring banks to establish living wills. He also noted that the biggest global banks tend be centered in the U.K. and stressed the importance of regulatory consistency with that jurisdiction.
Sen. Bob Corker (R-Tenn.) asked Volcker to clarify his intention with the Dodd-Frank provision that is named after him, the Volcker Rule, with regard to specifically focusing on banning proprietary trading activities. Corker noted that there have been attempts by regulators, in implementing the rule, to do away with market making and asked how market making and proprietary trading can be differentiated.
Volcker confirmed that his intention with the rule was to focus on proprietary trading. He said it is important for the management of banks, including the directors, to understand what the law says and to enhance the controls on banks’ trading desks to ensure the law is followed. He said traders at market making desks should not be taking proprietary risks under the guise of market making and that these differences can be identified by a number of metrics, including the size and volatility of trades. Volcker said that through these metrics supervisors should be able to identify signs of proprietary trading and subsequently raise appropriate questions to confirm whether this is the case.
Corker also asked whether identifying market making activities that make a profit for a firm as proprietary trading is regulatory overreach and if it is a legitimate thing for banks to be involved in holding small amounts of inventory that are held for their customers’ use.
Volcker agreed with Corker’s assertion of regulatory overreach and said profits can be made from market making. With regard to holding a small inventory, Volcker questioned why firms wanting to be prepared for market making don’t hold a short position “because the customer may want to sell. So they ought to have a balanced position, it seems to me, and if the position is very unbalanced it raises questions.”
Sen. Jeff Merkley (D-Ore.) noted certain criticisms of the Volcker Rule and asked Volcker whether he believed the provision would result in decreased liquidity.
Volcker said decreased liquidity would not necessarily lead to a problem and noted how markets were very liquid right before the crisis which led to some “unconstructive behavior” in the banking sector. He specifically pointed to the multitude of investment vehicles used to securitize mortgages and noted proposals in Europe to tax transactions to make the markets less liquid. Volcker said enough liquidity should exist to buy and sell reasonably but not to the point where a long-term security can be purchased and sold within “10 minutes” of each other and with “no risk.”
Sen. Mike Johanns (R-Neb.) voiced his concern with the complexity of the Volcker Rule and whether it may lead to more consolidation in the banking sector.
Volcker said prohibitions in the Volcker Rule will only apply to 6-8 institutions and that these firms are very sophisticated with strict controls over their trading desks. He said transactions do not have to be traced in real time and that regulators should “describe generally” the characteristics of proprietary trading.
Volcker said that with the reputation of a bank’s management at stake, they will make a good faith effort to stay within the framework of the rule’s restrictions.
Merkley noted that regulators may not be prepared to finalize the rule by its statutory effective date in July and asked whether they should still move forward and attempt to complete the rule by the summer.
Volcker said regulators are aiming to complete the rule by July and that they recognize that over the two year conformance period, they may want to change things in the provision. He did refer to interpretations of the Federal Reserve’s clarifying guidance on the conformance period that suggested firms can continue to engage in proprietary trading during that period, and stated that no proprietary trading can take place after the rule’s effective date in July 2012.
Panel II Q&A
Brown asked what growth and consolidation has meant in terms of the ability to effectively manage and monitor large financial firms.
Kroszner said “in principle” such firms are not too big to manage. He noted that more transparency would make it easier for regulators to monitor banking activities but noted that risks the rules are intended to address do not disappear, but may move to less regulated areas like the shadow banking sector. He said careful cost benefit analysis should be undertaken to identify any government subsidies that benefit certain types of firms over others and then to subsequently eliminate those subsidies.
Corker asked whether Hoenig believed Dodd-Frank makes the financial system less safe.
Hoenig referred to his proposal to take certain high risk activities and “move them out to the market where they can fail” which would then resolve any size and concentration issues among large financial firms. He said removing such activities would allow regional and community banks to compete on a more level playing field with the large banks.
Panel III Q&A
Brown asked Frost and Roselle, as banking practitioners, whether large banks are too big to manage.
Frost said a difference in cultures – one that is transactions-based and profit driven vs. one that is focused on building relationships with customers – make large banks impossible to manage. Frost said the Dodd-Frank Act failed to address this issue and that there needs to be a separation of cultures; where the customer-focused business can receive government safety nets while the transactions-based business would be allowed to fail.
Corker asked Roselle’s thoughts on Frost’s idea of separating banking activities in such a manner.
Roselle said it would be a mistake to establish an artificial separation and that banking services should be allowed to evolve through natural market forces. As an example, Roselle noted how Northern Trust evolved from a predominately wealth management firm to a custodian bank based on client demand. He also noted that enacting such a separation would not reduce risk and may actually drive activities to less regulated environments.
For testimony and webcast of the hearing, please click here.
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AT TODAY’S SENATE BANKING SUBCOMMITEE HEARING, lawmakers discussed the concentration of banking activities and the implications of such changes in the banking sector. The hearing consisted of three panels featuring former Federal Reserve Chairman Paul Volcker, Federal Deposit Insurance Corporation (FDIC) Board member Thomas Hoenig, Federal Reserve official Randall Kroszner, and a panel of industry representatives.
Subcommittee Chairman Sherrod Brown (D-Ohio) began the hearing by noting his intention of reintroducing the “SAFE Banking Act” which would impose a cap on any bank holding company’s share of the total insured deposits in the U.S. and would reduce the maximum amount of non-deposit liabilities at financial firms, among other things.
Testimony
In his opening statement, Paul Volcker noted that the greatest structural challenges facing the financial system is the perception of “too big to fail.” He said provisions in the Dodd-Frank Act deal with this issue, including the Volcker Rule. Volcker pointed to other issues that need to be addressed such as reform of the government sponsored enterprises (GSEs) and encouraging more private sector participation in housing finance activities, and reforming money market mutual funds (MMFs). Volcker noted how MMFs are vulnerable to runs in times of stress and said they need to be harnessed “in a manner that recognizes both their structural importance in diverting funds from regulated banks and their destabilizing potential.” He suggested MMFs be treated as ordinary mutual funds, “with redemption values reflecting day by day market price fluctuations.” Volcker also called for a member of the Federal Reserve to be designated as Vice Chairman for Supervision, a position that has not been filled nearly two years after its authorization.
Thomas Hoenig, FDIC Board member, submitted his paper “Restructuring the Banking System to Improve Safety and Soundness” from May 2011 as his statement for the record. The paper was written when Hoenig served as President and CEO of the Federal Reserve Bank of Kansas City and outlines proposals to “reintroduce accountability” by restricting bank activities.
Randall Kroszner, Member-Designate of the Federal Reserve Board, submitted his paper on “Stability, Growth and Regulatory Reform” from April 2012 as his statement for the record. The paper discusses the value of financial innovation and the effects regulatory reform efforts have on the financial system.
In his opening statement, Tom Frost, Chairman Emeritus of Frost National Bank, discussed how the banking business has evolved into two different cultures – one that is transactions-based and one that is based on customer relationships. He suggested these cultures be separated and that government support should not be given to hedging and speculative services.
In his opening statement, Marc Jarsulic, Chief Economist for Better Markets, Inc., discussed how high leverage , proprietary trading, and dependence on unstable short term financing made large financial firms vulnerable during the financial crisis. Jarsulic suggested the Volcker Rule place “meaningful leverage and liquidity requirements on bank broker dealers” and lower the permitted leverage. He also suggested the repo market be designated and supervised by the Financial Stability Oversight Council in order to enact effective regulation of the shadow banking system.
In his opening statement, James Roselle, Associate General Counsel for Northern Trust Corporation, highlighted specific provisions in the proposed Volcker Rule that may have negative impacts on firms that Congress did not intend for the rule to cover. Those concerns include “the overly broad definition of “covered fund” and the impact that so-called “Super 23A prohibitions will have on custody-related transactions; the proposed inclusion of foreign exchange swaps and forwards in the proprietary trading restrictions; and the unnecessary and onerous proposed compliance requirements.”
In his opening statement, Anthony Carfang, Partner at Treasury Strategies, Inc., who testified on behalf of the U.S. Chamber of Commerce, discussed regulatory reform provisions that may have negative effects on capital raising methods for businesses. Carfang noted that “artificial and arbitrary caps on the financial industry, or the Volcker Rule (as currently proposed), or additional money market regulation will not reduce systemic risk.” He said such regulation will force “non-financial companies that are the engines of our economy to retrench, enhance their cash positions and face a much tougher time raising the capital needed to operate, grow and create jobs.”
Panel I Q&A
Brown addressed the issue of moral hazard with regard to large financial institutions and asked Volcker what regulators can do to send the message to markets that such firms will not be propped up by the government if they get into trouble.
Volcker said provisions in Dodd-Frank will assist in the orderly liquidation of a large firm, including authorizing the FDIC with powers of conservatorship and requiring banks to establish living wills. He also noted that the biggest global banks tend be centered in the U.K. and stressed the importance of regulatory consistency with that jurisdiction.
Sen. Bob Corker (R-Tenn.) asked Volcker to clarify his intention with the Dodd-Frank provision that is named after him, the Volcker Rule, with regard to specifically focusing on banning proprietary trading activities. Corker noted that there have been attempts by regulators, in implementing the rule, to do away with market making and asked how market making and proprietary trading can be differentiated.
Volcker confirmed that his intention with the rule was to focus on proprietary trading. He said it is important for the management of banks, including the directors, to understand what the law says and to enhance the controls on banks’ trading desks to ensure the law is followed. He said traders at market making desks should not be taking proprietary risks under the guise of market making and that these differences can be identified by a number of metrics, including the size and volatility of trades. Volcker said that through these metrics supervisors should be able to identify signs of proprietary trading and subsequently raise appropriate questions to confirm whether this is the case.
Corker also asked whether identifying market making activities that make a profit for a firm as proprietary trading is regulatory overreach and if it is a legitimate thing for banks to be involved in holding small amounts of inventory that are held for their customers’ use.
Volcker agreed with Corker’s assertion of regulatory overreach and said profits can be made from market making. With regard to holding a small inventory, Volcker questioned why firms wanting to be prepared for market making don’t hold a short position “because the customer may want to sell. So they ought to have a balanced position, it seems to me, and if the position is very unbalanced it raises questions.”
Sen. Jeff Merkley (D-Ore.) noted certain criticisms of the Volcker Rule and asked Volcker whether he believed the provision would result in decreased liquidity.
Volcker said decreased liquidity would not necessarily lead to a problem and noted how markets were very liquid right before the crisis which led to some “unconstructive behavior” in the banking sector. He specifically pointed to the multitude of investment vehicles used to securitize mortgages and noted proposals in Europe to tax transactions to make the markets less liquid. Volcker said enough liquidity should exist to buy and sell reasonably but not to the point where a long-term security can be purchased and sold within “10 minutes” of each other and with “no risk.”
Sen. Mike Johanns (R-Neb.) voiced his concern with the complexity of the Volcker Rule and whether it may lead to more consolidation in the banking sector.
Volcker said prohibitions in the Volcker Rule will only apply to 6-8 institutions and that these firms are very sophisticated with strict controls over their trading desks. He said transactions do not have to be traced in real time and that regulators should “describe generally” the characteristics of proprietary trading.
Volcker said that with the reputation of a bank’s management at stake, they will make a good faith effort to stay within the framework of the rule’s restrictions.
Merkley noted that regulators may not be prepared to finalize the rule by its statutory effective date in July and asked whether they should still move forward and attempt to complete the rule by the summer.
Volcker said regulators are aiming to complete the rule by July and that they recognize that over the two year conformance period, they may want to change things in the provision. He did refer to interpretations of the Federal Reserve’s clarifying guidance on the conformance period that suggested firms can continue to engage in proprietary trading during that period, and stated that no proprietary trading can take place after the rule’s effective date in July 2012.
Panel II Q&A
Brown asked what growth and consolidation has meant in terms of the ability to effectively manage and monitor large financial firms.
Kroszner said “in principle” such firms are not too big to manage. He noted that more transparency would make it easier for regulators to monitor banking activities but noted that risks the rules are intended to address do not disappear, but may move to less regulated areas like the shadow banking sector. He said careful cost benefit analysis should be undertaken to identify any government subsidies that benefit certain types of firms over others and then to subsequently eliminate those subsidies.
Corker asked whether Hoenig believed Dodd-Frank makes the financial system less safe.
Hoenig referred to his proposal to take certain high risk activities and “move them out to the market where they can fail” which would then resolve any size and concentration issues among large financial firms. He said removing such activities would allow regional and community banks to compete on a more level playing field with the large banks.
Panel III Q&A
Brown asked Frost and Roselle, as banking practitioners, whether large banks are too big to manage.
Frost said a difference in cultures – one that is transactions-based and profit driven vs. one that is focused on building relationships with customers – make large banks impossible to manage. Frost said the Dodd-Frank Act failed to address this issue and that there needs to be a separation of cultures; where the customer-focused business can receive government safety nets while the transactions-based business would be allowed to fail.
Corker asked Roselle’s thoughts on Frost’s idea of separating banking activities in such a manner.
Roselle said it would be a mistake to establish an artificial separation and that banking services should be allowed to evolve through natural market forces. As an example, Roselle noted how Northern Trust evolved from a predominately wealth management firm to a custodian bank based on client demand. He also noted that enacting such a separation would not reduce risk and may actually drive activities to less regulated environments.
For testimony and webcast of the hearing, please click here.