Since the crisis, the financial industry has built up significant capital to enhance the resiliency of the financial system. A proxy for the entire financial system, Common Equity Tier 1 (CET1) is up 71% since 2009 for firms subject to the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR). Their average CET1 ratio is 11.8%, well above the 7% minimum requirement and even greater than the maximum regulatory requirement inclusive of the highest G-SIB surcharge.

With the adoption of numerous conservative prudential regulatory requirements, banks now hold excessive levels of capital and liquidity that are increasingly disconnected from the level of risk they incur. Although these levels have undoubtedly increased resiliency, they come at a cost: the more capital required, the less deployed into the economy.

Prudential and market regulators have set out to tailor and improve upon the post-crisis regulatory regime, executing on recommendations put forth by the Treasury Department to rebalance and modernize financial regulation. To that end, industry and regulators have been examining the necessary revisions to several major rules adopted over the last ten years. For example, today, we are patiently awaiting the next iteration of the Volcker Rule, as well as next steps on stress testing, Basel IV implementation (Basel IV), the fundamental review of the trading book (FRTB), the enhanced supplemental leverage ratio (eSLR), the net stable funding ratio (NSRF), internal TLAC requirements, and Congressionally mandated tailoring for domestic and foreign banking organizations, to name a few top priority concerns.

At the 6th annual Prudential Regulation Conference, SIFMA and the Bank Policy Institute gathered policymakers and practitioners to assess how the post-crisis prudential regulatory framework is affecting the capital markets, including market liquidity, capital formation and innovation. These are highlights from our discussions.

The Need for a Holistic Review: One-on-One with H. Rodgin Cohen

“We need to resolve what is an inherent tension between regulation on one side and the ability of financial institutions to support the economy and provide liquidity on the other. There is no absolute clear methodology for resolving that tension and it depends on the time. It was one thing in 2008 and 2009; it is very different here.”

“I absolutely think there needs to be a thoughtful consideration of double counting and cumulative impact…We’ve all heard the adage about belts and suspenders. You can look upon the published capital requirements as the belt and you can look upon CCAR as the suspenders (so maybe that is what is really holding up the pants). The real concern is with some of the side elements of CCAR and capital requirements, such as GMS. Are we now creating belt, suspenders – and a regulatory noose?”

“The whole capital structure needs to be looked at, the regulatory structure holistically, with a particular focus on capital market activities. There’s no mystery here, the Fed isn’t hiding it: they are worried about capital markets activity… There are issues, there are all sorts of remedies, including liquidity tests. In a sense it’s not just that there are duplicative capital requirements and duplicative liquidity requirements. The two of them duplicate one another to an extent in terms of restraints on activities. That’s why we need that holistic view.

H. Rodgin Cohen
Senior Chairman
Sullivan & Cromwell LLP

Forces Shaping Money Market Conditions: The Fed’s Declining Balances Meets the LCR

“This is a very useful chart and it’s also an extremely dangerous chart. This shows the way it works on average… You’re going to hold an asset mix in whatever the cheapest way is to meet your regulatory requirement. If reserves are cheap, you’ll hold a lot more reserves; if Treasuries are cheap, you’ll hold a lot more Treasuries. As the relative price of these things shift, you can get massive movements in this curve.

What I do day-to-day is spend a lot of time figuring out where the stress points are: [regulation has] created a lot of rigidity in the system. It can handle an average day perfectly fine but if there is a shock to the system it is very difficult to shift capital to where it needs to be; there are many more constraints in the system than what we used to have so what it means is market price action is much more severe.”

Michael Cloherty
Head of U.S. Rates Strategy
RBC Capital Markets, LLC

Stress Testing/CCAR and the Capital Markets

“The risk profile of the capital markets has changed significantly. In 2008, margin rules were substantially different; in 2008 we didn’t have LCR; in 2008 the securitization rules were much different. So as a result of a lot of that regulatory change, it incentivized different behaviors. One of the things we’re trying to think through in this paper is how is the right way to calibrate it, given the world has changed significantly from where we were in 2008. The goal of this is to identify areas we’d like to collaborate with the Federal Reserve on and actually start a dialogue, not just with the Fed but with other trade associations, individual organizations, academia, so we can have an open, impartial, unbiased way with pushing forward a stress testing tool that is helpful, more precise, and more sophisticated.”

Coryann Stefansson
Senior Advisor
SIFMA

Coordination, Collaboration and Innovation: A Discussion with SEC Commissioner Peirce and CFTC Commissioner Quintenz

“Sometimes bank regulators don’t appreciate the value of capital markets. Hedging is a really important function, and one that makes our companies stronger, because they’re able to hedge their risk. The capital markets are all about risk-taking, and bank regulators have a real problem with that. It can be very frustrating, because the temptation can be to impose bank-like rules on pieces of the capital markets system. And that’s frustrating to me, because one of the things I want to encourage, is to say the risk-taking is healthy.”

Hester M. Peirce
Commissioner
U.S. Securities and Exchange Commission (SEC)

“If we’re penalizing uncleared swaps, we’re penalizing innovation, and I question whether or not we’d achieve the gains we have today if these rules had been in place 10 years ago. So I think the impacts are large and significant, and we all need to be aware of them.”

Brian D. Quintenz
Commissioner
U.S. Commodity Futures Trading Commission (CFTC)

December 2018 Freeze in the Markets: A Deeper Look

“What we’ve seen anecdotally and what our researchers have actually measured very precisely is how when volatility increases, liquidity drops off much more rapidly than it has in the past… When you need liquidity the most, it is nowhere to be found.”

“The cumulative impact of all of these regulations, changes and things that we have seen over the past 10-12 years since the crisis, has made it very, very expensive to be a market maker, a bank market maker in these businesses. As a result, we should continually examine whether these cumulative rules are providing sufficient safety and soundness benefits where capital may otherwise be used to drive economic growth.”

Thomas Pluta
Co-Head of Global Rates Trading
JPMorgan Chase & Co.

A Look at the Impact of Prudential Regulation on Capital Market Liquidity

Does prudential regulation affect market liquidity? If so, how?

“One of the things that’s clear over the last 10 years is that there has been a significant and generally positive effort on behalf of regulators and the industry to undertake a number of enhancements that promote overall resilience. That touches the gamut of regulatory space within the financial services. We’re talking about higher capital standards, higher liquidity standards, stress testing for both capital and liquidity, getting into TLAC standards, resolution standards to prove resilience. I think all of those have been a hallmark of what has happened over the last 10 years.”

Kevin Bailey
Global Head of Regulatory Affairs
Citigroup

The Tailoring Regimen and Market Fragmentation: A Conversation with the Fed’s Mark Van Der Weide

“One of the key agenda items at the FSB over the coming year – and it’s almost certain to continue into the coming year 2020 – is a look at market fragmentation and to take a look at what the market fragmentation results have been from all the different regulations that we have passed and to see whether we have struck the right balance… We’re definitely going to be in the coming year taking a hard look at a number of different TLAC elements to see if we got that right.”

“One of the themes of the post-crisis financial regulatory environment has been tailoring. We’ve done quite a bit of tailoring already. We’re doing quite a bit of tailoring now and I think there is more tailoring to come. Part of the point, I think, of tailoring is to make sure that for the smaller banks and smaller dealers, medium banks and medium dealers they aren’t subject to as burdensome a regulatory regime as the larger firms… One of the effects of the tailoring regime is to help the smaller firms and medium-sized firms compete with the larger firms. I would hope as we tailor more and more of a regulatory framework, we’ll see more and more smaller and medium firms not have the same regulatory impediments to competition.”

“There are cases clearly where we have regulated in an excessively stringent way. That’s part of the process we’re going through now as we do a review of the regulations to see where we’ve miscalibrated or have overlapping things that could be simplified… Where we’ve seen an issue and where we recognize that maybe we excessively calibrated some capital requirement or liquidity requirement, we’ll go in and fix that. But it’s going to be case by case, issue by issue, asset class by asset class, after careful analysis because that’s who we are.”

Mark E. Van Der Weide
General Counsel
Federal Reserve Board

Terms to Know: Prudential Regulation

Terms to Know: Prudential Regulation

BHC	Bank Holding Company
G-SIB	Global Systemically Important Bank
LEI	Legal Entity Identifier
QIS	Quantitative Impact Study
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B3	Basel III International Regulatory Framework for Banks
CCAR	Comprehensive Capital Analysis and Review
CLAR	Comprehensive Liquidity Analysis and Review
DFA	Dodd-Frank Wall Street Reform and Consumer Protection Act
EMIR	European Market Infrastructure Regulation
MiFID	Markets in Financial Instruments Directive
MiFID II	Markets in Financial Instruments Directive (revised)
MiFIR	Markets in Financial Instruments Regulation
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CET1	Common Equity Tier 1
T1C	Tier 1 Capital
AT1	Additional Tier 1 Capital
T2C	Tier 2 Capital
TLAC	Total Loss-Absorbing Capacity
RWA	Risk-Weighted Assets
CVA	Credit Valuation Adjustment
CTP	Correlation Trading Portfolio
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LCR	Liquidity Coverage Ratio
HQLA	High Quality Liquid Assets
NCOF	Net Cash Outflows
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NSFR	Net Stable Funding Ratio
ASF	Available Amount of Stable Funding
RSF	Required Amount of Stable Funding
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SLR	Supplemental Leverage Ratio
TE	Total Exposure
PFE	Potential Future Exposure
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FRTB	Fundamental Review of the Trading Book

Carter McDowell is Managing Director, Associate General Counsel at SIFMA. Mr. McDowell reviews and advises the association on legislation, amendments and prudential regulations impacting the financial services industry in the U.S. and globally.