Prepared Testimony of Kenneth E. Bentsen, Jr., President and CEO

Securities Industry and Financial Markets Association (SIFMA)

before the U.S. House of Representatives

Committee on Financial Services

Subcommittee on Financial Institutions and Monetary Policy

September 25, 2024

Introduction

Chairman Barr, Ranking Member Foster, and distinguished members of the Subcommittee, thank you for the opportunity to testify today on the Basel III Endgame proposal and other rulemakings currently being considered by the banking regulators. My name is Ken Bentsen, and I am the President and CEO of the Securities Industry and Financial Markets Association (“SIFMA”).¹

I would like to start by commending the members represented on this Subcommittee for their leadership on these important issues, including via the many comment letters on the Basel III Endgame and other capital proposals that members from both parties have submitted to the regulators, as well as through hearings on these and other related topics over the past year.

While bank capital requirements are an undoubtedly complex subject, there is no question that they have material impacts across the entire economy, affecting the ability of corporations, small businesses, governmental organizations, and consumers to fund their activities and manage all types of risks. Given these impacts, it’s crucial that policymakers, including Congress, conduct sufficient analysis and oversight to ensure that bank capital requirements strike the appropriate balance between ensuring financial stability and macroeconomic growth.

In this context, it is worth noting that the quantity of high-quality capital in the U.S. banking system has increased three-fold since the Global Financial Crisis, while total loss absorbing capacity has increased six-fold and liquidity levels have increased twelve-fold. Many independent studies have also found capital levels at the largest U.S. banks to either be at or close to their “optimal” levels.2 And senior policymakers, including Treasury Secretary Yellen, Federal Reserve Chair Powell, and Federal Reserve Vice Chair for Supervision Michael Barr, amongst others, have commented in recent years that the U.S. banking system is strong, resilient, and “well-capitalized.”² In other words, it appears that capital levels are already robust and any further proposed increases should be sufficiently scrutinized to determine both the tangible benefits, and costs to the broader U.S. economy.

It is particularly important that policymakers strike the right balance when it comes to capital requirements affecting the ability of large banking organizations to act as intermediaries in our capital markets, given that those markets fund roughly three quarters of all economic activity in the United States. This contrasts with other major economies where the vast majority of commercial and economic activity is overly reliant on bank balance sheets and we believe the data has proven the U.S. model to be more efficient, resilient and growth oriented. In fact, the EU and many Asian nations aspire to develop their capital markets to mimic the U.S. model. Excessive capital requirements on banks’ markets activities would negatively impact the depth, liquidity and resiliency of the capital markets and increase costs at the expense of consumers and commercial entities who benefit directly and indirectly from bank involvement in such activities.

Reforming the Basel III Endgame Proposal

SIFMA has expressed deep concern about the Basel III Endgame proposal that was issued last year by the banking regulators, not only because it would significantly increase aggregate U.S. bank capital levels well beyond their current, historically robust levels, but because it inappropriately targets banking organizations’ capital markets activities for some of the largest increases. The industry quantitative impact study conducted on the original Basel III Endgame proposal estimated that capital for large banks’ trading activities would increase by 129% above their current historically high levels because of the Fundamental Review of the Trading Book (“FRTB”) and Credit Valuation Adjustment (“CVA”) changes, impacts that were far greater than the agencies’ original estimates, a consequence of the fact that they did not conduct a proper quantitative impact assessment prior to issuing the original proposal.³

As we and many other commentors explained, the increases arising from the original proposal would not be commensurate with the underlying risks posed by these activities and would have serious knock-on effects for the capital markets and real economy. For example, a PWC study released in June 2024 found that the original Basel III Endgame proposal would cause U.S. economic growth to decline by up to 56bps, equivalent to a reduction in growth of up to 25% over the last 10 years.⁴ Moreover, these impacts are not purely hypothetical: we have already seen this negative impact occurring as some firms have indicated intentions to scale back specific business lines.⁵ Finally, by “gold plating” the Basel standards, the U.S. would diverge from the implementation approaches taken in other major jurisdictions such as the EU and UK, undermining one of the goals of the Basel agreement, which was aimed at promoting greater cross-border harmonization and comparability across capital requirements.

The recent comments of Federal Reserve Vice Chair for Supervision Michael Barr earlier this month⁶, announcing the agencies’ intent to issue a re-proposal of both the Basel III Endgame rule and the related Global Systemically Important Bank (“GSIB”) surcharge rule, was therefore a welcome first step. We are concerned that the re-proposal would still raise capital levels by an additional 9% for the largest U.S. banks above levels that are already comparatively high by international standards, and in contrast to other major jurisdictions where implementation is expected to be closer to capital neutral in the aggregate.

Nonetheless, we commend the agencies for acknowledging the need to make “broad and material revisions” to the Basel III Endgame rule based on their analysis of the data collected after the original proposal was issued and the comments they received, and we look forward to providing our comments and analysis on both the re-proposals and QIS once they are released. In evaluating the rule re-proposals, we will be looking to see whether and to what extent they address our key recommendations.

These include:

1. Addressing the Overlaps with the Stress Tests/Other Capital Requirements: Any re-proposal of the Basel Endgame should account for overlaps with other prudential requirements, particularly overlaps with the stress testing framework, as well as the other pending capital proposals – i.e., the GSIB surcharge and long-term debt rules. It is crucial that regulators take a holistic view on these pending rulemakings and finalize them in conjunction with one another.
2. Accounting for the Interactions between the Global Market Shock (“GMS”) & the FRTB: Regulators should address the overcapitalization of market risk between these two frameworks by, for example, applying the FRTB to banks’ trading portfolios on a post-GMS shock basis. They should also only apply the Stress Capital Buffer (“SCB”) annual stress to the U.S. standardized approach to avoid over capitalizing the CVA and operational risk measures, which are already captured under the Basel Endgame’s proposed expanded risk-based approach.
3. Diversification: Although not mentioned in Vice Chair Barr’s remarks, an important reform would be giving greater credit for diversification under both the modeled and standardized FRTB approaches to better align with actual risk exposures and reward good risk management practices. It is crucial that greater diversification recognition be included in the final rule.
4. Internal Models: We appreciate Vice Chair Barr’s statement that the re-proposal will include “changes to facilitate banks’ ability to use internal models for market risk,” given that internal models better reflect firms’ risk profiles. However, the specifics will matter. In the FRTB portion of the proposal, adjustments will need to be made to the capital requirements for modellable risk factors (“IMCC”) and non-modellable risk factors (“NMRF”) in addition to the P&L loss attribution (“PLAT”) test in order to facilitate greater use of internal models approaches.
5. Derivatives: Under the original proposal, the additional capital requirements for derivatives could require banks passing on additional costs of greater than $10 billion per annum, while the cost to hedge interest rate risks would likely increase by nearly 10 bps, significant increases that would lead to higher costs for businesses and consumers.⁷ While Vice Chair Barr did indicate that the capital treatment for the client-facing leg of client-cleared derivatives transactions will be reduced, we continue to believe that these transactions should be excluded altogether from scope of the CVA. Moreover, we believe that over-the-counter derivatives transactions with commercial end-users need to receive more favorable treatment in the final U.S. rule to bring that treatment into line with the approach adopted by the EU, UK, and other major jurisdictions and consistent with longstanding policies designed to facilitate prudent risk management practices derivatives. We also recommend that CVA risk weights should also be adjusted to reflect the different levels of regulation that a bank’s financial counterparties are subject to.
6. Securitizations: In his remarks, Vice Chair Barr did not comment on possible revisions to the proposed treatment of securitizations, a key concern for SIFMA and its members. Securitized products provide significant economic benefits by lowering borrowing costs on a wide variety of consumer and business loans such as mortgages, equipment, inventory, auto and student loans, and credit cards. They also help banks to prudently manage their exposures. However, the Basel III Endgame proposal, by doubling the regulator set “p-factor,” would create perverse risk incentives that would discourage large banks from engaging in securitization activities; for example, it would increase the capital requirements for certain senior securitization exposures much more than relatively junior (and thus riskier) exposures. Capital treatment for securitization exposures in other major jurisdictions is materially less punitive than the U.S. proposal. We have made several recommendations for addressing this undue punitive treatment.⁸ One straight forward fix is to keep the p-factor at its current level rather than doubling it.
7. Securities Financing Transactions (“SFT”) Haircut Framework: We welcome indications that the proposed SFT haircut framework will not be adopted in the U.S., given the significant adverse effects on the critical securities borrowing and lending markets that it would have. Removing this framework would also align the U.S. with the approach taken by other major jurisdictions.
8. Investment grade counterparties and collateral: We have also advocated for the removal of the so-called public listing requirement, which would penalize credit worthy counterparties that do not have publicly listed securities such as pension funds and municipal issuers. Vice Chair Barr’s remarks suggest that this treatment will be revised in line with the approach taken by the EU and UK, but we
9. Operational risk: We welcome the apparent decision to revise the operational risk framework to provide for the netting of income and expenses related to fee-based capital markets services. While we will need to review the details, this type of change would better incentivize sound risk management practices and diversified business models. This is particularly important to critical functions such as retail financial advisory services and investment banking. The agencies should address other issues that arise from the application of standards that are designed for top-tier entities to subsidiaries, an example of which is the operational risk framework’s treatment of inter-affiliate reimbursements, which unduly penalizes the subsidiaries of foreign banking organizations (“FBOs”) that are crucial to the strength of the U.S. capital markets.⁹
10. Implementation Timeline: Finally, the agencies should provide clarity around the Basel III implementation timeline in their re-proposal. We have called on the regulators to provide at least 18 months from completion of the final rule for firms to begin implementing the new framework.

1. SIFMA is the leading trade association for broker-dealers, investment banks and asset managers operating in the U.S. and global capital markets. On behalf of our industry’s nearly 1 million employees, we advocate for legislation, regulation and business policy, affecting retail and institutional investors, equity and fixed income markets and related products and services. We serve as an industry coordinating body to promote fair and orderly markets, informed regulatory compliance, and efficient market operations and resiliency. We also provide a forum for industry policy and professional development. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA). For more information, visit http://www.sifma.org. [↩]
2. See Financial Services Forum, “What They’re Saying: Policymaker son Capital Levels an the Largest Banks.” Available at: https://fsforum.com/a/media/what-they%E2%80%99re-saying–policymakers-on-capital-levels-and-the-largest-banks.pdf. [↩]
3. For additional background on the industry quantitative impact study analysis and SIFMA’s response to the original Basel III Endgame re-proposal, see SIFMA, ISDA Comments on the Market Risk Components, January 16, 2024. Available at: https://www.sifma.org/wp-content/uploads/2024/01/ISDA-SIFMA-Comment-Letter-January-16-2024-Basel-III-Endgame.pdf. See also SIFMA, FIA Comments on the Operational Risk Components, January 16, 2024. Available at: https://www.sifma.org/wp-content/uploads/2024/01/SIFMA-FIA-Op-Risk-Comment-Letter-Final-1.16.2024.pdf. More information can also be found in SIFMA’s Blog Series on the Basel III Endgame, available at: https://www.sifma.org/resources/news/basel-iii-endgame-blog-series/. [↩]
4. PWC, “Basel III Endgame: Assessing the bigger picture,” June 2024. Available at: https://explore.pwc.com/c/basel-iii-endgame-bigger-picture?x=v0trZH. [↩]
5. Investment News, “Citigroup to Exit Distressed Debt Business,” December 31, 2023. Available at: https://www.investmentnews.com/industry-news/citigroup-to-exit-distressed-debt-business/247395. See also: The Financial Times, “Barclays Explores Plan to Drop Thousands of Investment Banking Clients,” November 28, 2003. Available at: https://www.ft.com/content/ff5b56d8-51a3-48f6-b7e5-5854abcf219a. [↩]
6. Michael S. Barr, “The Next Steps on Capital,” Remarks at the Brookings Institution, September 10, 2024. Available at: https://www.federalreserve.gov/newsevents/speech/barr20240910a.htm. [↩]
7. See PWC Report, June 2024. [↩]
8. For an overview of this issue and our recommendations, see the blog attached in the Appendix: Guowei Zhang and Chris Killian, “How the Basel III Endgame Could Impair Securitization Markets and Harm US Businesses and Consumers,” November 28, 2023. Available at: https://www.sifma.org/resources/news/how-the-basel-iii-endgame-could-impair-securitization-markets-and-harm-us-businesses-and-
   consumers/. [↩]
9. For more on the vital role that FBOs play in the U.S. capital markets, see SIFMA Insights, “The Importance of FBOs to the U.S. Capital Markets,” April 2019. Available at: https://www.sifma.org/wp-content/uploads/2019/04/SIFMA-Insights-The-Importance-of-FBOs-to-US-Capital-Markets.pdf. [↩]