[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
EXAMINING CAPITAL REGIMES FOR
FINANCIAL INSTITUTIONS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
AND CONSUMER CREDIT
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
__________
JULY 17, 2018
__________
Printed for the use of the Committee on Financial Services
Serial No. 115-109
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
U.S. GOVERNMENT PUBLISHING OFFICE
31-508PDF WASHINGTON : 2018
HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PATRICK T. McHENRY, North Carolina, MAXINE WATERS, California, Ranking
Vice Chairman Member
PETER T. KING, New York CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma BRAD SHERMAN, California
STEVAN PEARCE, New Mexico GREGORY W. MEEKS, New York
BILL POSEY, Florida MICHAEL E. CAPUANO, Massachusetts
BLAINE LUETKEMEYER, Missouri WM. LACY CLAY, Missouri
BILL HUIZENGA, Michigan STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin DAVID SCOTT, Georgia
STEVE STIVERS, Ohio AL GREEN, Texas
RANDY HULTGREN, Illinois EMANUEL CLEAVER, Missouri
DENNIS A. ROSS, Florida GWEN MOORE, Wisconsin
ROBERT PITTENGER, North Carolina KEITH ELLISON, Minnesota
ANN WAGNER, Missouri ED PERLMUTTER, Colorado
ANDY BARR, Kentucky JAMES A. HIMES, Connecticut
KEITH J. ROTHFUS, Pennsylvania BILL FOSTER, Illinois
LUKE MESSER, Indiana DANIEL T. KILDEE, Michigan
SCOTT TIPTON, Colorado JOHN K. DELANEY, Maryland
ROGER WILLIAMS, Texas KYRSTEN SINEMA, Arizona
BRUCE POLIQUIN, Maine JOYCE BEATTY, Ohio
MIA LOVE, Utah DENNY HECK, Washington
FRENCH HILL, Arkansas JUAN VARGAS, California
TOM EMMER, Minnesota JOSH GOTTHEIMER, New Jersey
LEE M. ZELDIN, New York VICENTE GONZALEZ, Texas
DAVID A. TROTT, Michigan CHARLIE CRIST, Florida
BARRY LOUDERMILK, Georgia RUBEN KIHUEN, Nevada
ALEXANDER X. MOONEY, West Virginia
THOMAS MacARTHUR, New Jersey
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana
Shannon McGahn, Staff Director
Subcommittee on Financial Institutions and Consumer Credit
BLAINE LUETKEMEYER, Missouri, Chairman
KEITH J. ROTHFUS, Pennsylvania, WM. LACY CLAY, Missouri, Ranking
Vice Chairman Member
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
BILL POSEY, Florida DAVID SCOTT, Georgia
DENNIS A. ROSS, Florida NYDIA M. VELAZQUEZ, New York
ROBERT PITTENGER, North Carolina AL GREEN, Texas
ANDY BARR, Kentucky KEITH ELLISON, Minnesota
SCOTT TIPTON, Colorado MICHAEL E. CAPUANO, Massachusetts
ROGER WILLIAMS, Texas DENNY HECK, Washington
MIA LOVE, Utah GWEN MOORE, Wisconsin
DAVID A. TROTT, Michigan CHARLIE CRIST, Florida
BARRY LOUDERMILK, Georgia
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
C O N T E N T S
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Page
Hearing held on:
July 17, 2018................................................ 1
Appendix:
July 17, 2018................................................ 37
WITNESSES
Tuesday, July 17, 2018
Baer, Hon. Greg, President, Bank Policy Institute................ 5
Fromer, Hon. Kevin, President and Chief Executive Officer,
Financial Services Forum....................................... 4
Holtz-Eakin, Douglas, President, American Action Forum........... 7
Noreika, Keith A., Partner, Simpson Thacher & Bartlett........... 10
Stanley, Marcus, Policy Director, Americans for Financial Reform. 9
APPENDIX
Prepared statements:
Baer, Hon. Greg.............................................. 38
Fromer, Hon. Kevin........................................... 67
Holtz-Eakin, Douglas......................................... 78
Noreika, Keith A............................................. 84
Stanley, Marcus.............................................. 101
Additional Material Submitted for the Record
Clay, Hon. Wm. Macy:
Comment letters from Americans for Financial Reform (AFR).... 109
Written statement from Better Markets, Inc................... 153
Written statement from the Center for American Progress...... 184
Written statement from Stephen G. Cecchetti and Kermit L.
Schoenholtz................................................ 234
EXAMINING CAPITAL REGIMES FOR
FINANCIAL INSTITUTIONS
----------
Tuesday, July 17, 2018
U.S. House of Representatives,
Subcommittee on Financial Institutions
and Consumer Credit,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:02 p.m., in
room 2128, Rayburn House Office Building, Hon. Blaine
Luetkemeyer [chairman of the subcommittee] presiding.
Present: Representatives Luetkemeyer, Rothfus, Lucas,
Posey, Ross, Pittenger, Barr, Tipton, Williams, Trott,
Loudermilk, Kustoff, Tenney, Clay, Maloney, Scott, Green, Heck,
and Crist.
Chairman Luetkemeyer. The committee will come to order.
Without objection, the Chair is authorized to declare a recess
of the committee at any time. This hearing is entitled,
``Examining Capital Regimes for Financial Institutions.''
Before we begin, I would like to thank the witnesses for
appearing today. We appreciate your participation. And, quite
frankly, everybody is jealous of our panel today. We have a
very, very distinguished panel. Thank you, all, for being here,
and we certainly look forward to and anticipate your testimony.
I now recognize myself for 5 minutes for purposes of
delivering an opening statement.
Last April, this subcommittee held a hearing to examine the
state of Federal financial regulation and the impact regulators
and their perspective regimes were having on institutions,
their customers and the U.S. economy. Sitting on the front row
of the dais were stacks of paper representing 20,000 to 30,000
pages the average bank submits to the Federal Reserve for its
annual CCAR (Comprehensive Capital Analysis and Review) review
process. That is 20,000 to 30,000 pages per bank per year just
for CCAR.
Fast forward a little more than a year, and I am pleased to
report that the first time, in a long time, progress has been
made and some relief has been granted. Thanks, in large part,
to the effort of the Members of this committee and our
colleagues in the Senate and a President who champions
regulatory reform.
CCAR doesn't burden nearly as many institutions as it did 1
year ago. While some relief has been seen, it is widely
recognized that there is more work to be done.
In a January speech, the newly minted Federal Reserve Vice
Chairman for Supervision, Randy Quarles, outlined his vision by
stating that, and I quote, ``simplicity of regulation is a
principle that promotes public understanding of regulation,
promotes meaningful compliance by the Industry of Regulation,''
and reduces unexpected negative in synergies among regulations.
Confusion that results from overly complex regulation does not
advance the goal of a safe system. End quote.
Vice Chairman Quarles went on to indicate support for
changes to the resolution planning process and stress-test
programs, acknowledging substantial progress made by financial
institutions in the last few years.
His quasi predecessor, Governor Dan Tarullo, said in his
departure speech last year, and I quote, ``the time may be
coming when the qualitative objection in CCAR should be phased
out and supervisory examination work around stress testing and
capital planning completely moved into the normal, year-round
supervisory process, even for G-SIBs.'' End quote.
While we didn't agree on much during his tenure, Governor
Tarullo and I had at least one thing in common, the idea that
capital is a good thing. Capital protects institutions and
for--and, more importantly, consumers against loss and guards
the financial system against threats of collapse. While I
believe in robust capital requirements, I don't think capital
should be required to the point that it consolidates risk and
eliminates choice in the marketplace for commercial individual
clients.
The reality is that we still live in a world where the
financial regulatory regime stifles growth and limits the
availability of financial products. The new crop of Federal
financial regulators, in an effort to right-size regulation,
are considering additional measures, including tailoring to
provide relief to institutions of all sizes. As they do so, I
would first urge them to implement the statutory changes,
included in Senate bill 2155 without delay and do so while
closely adhering to what is clear congressional intent.
It is time for the Federal Reserve to also conduct a
holistic review and acknowledge that the world has changed
since the enactment of Dodd-Frank and the finalization of the
capital requirements on the books today. Such review should
include a consideration of equal and reasonable treatment for
institutions with more than $250 billion in assets and for
immediate holding companies--or intermediate holding companies
of international banks operating in the United States.
These institutions should be subjected to tailored
regulation that reflects the risk they pose to the financial
system. Such steps would not only reflect the intent of
Congress but also the Administration, evidenced most clearly
through the recommendations issued by the Treasury Department
since President Trump took office.
It is time to take the guessing out of capital planning and
regulation. I press leadership at each of the Federal financial
regulatory agencies to recommit to greater transparency and
adherence to the requirements in the Administrative Procedures
Act. We need smarter streamlined regulatory regimes that
promote not just transparencies, but also effective tax payer
and systemic protections.
We have a very distinguished panel of witnesses before us
today. Each of these gentlemen has an honorable background, and
we appreciate their testimony.
The Chair now recognizes the Ranking Member of the
subcommittee, the gentleman from Missouri, Mr. Clay, for 5
minutes for an opening statement.
Mr. Clay. Thank you, Mr. Chair, and thank you for
conducting this hearing. At this time, I am going to be going
back and forth to a business meeting in the Oversight and
Government Reform Committee. We are expecting votes, so I will
designate Mr. Scott, of Georgia, as the ranking Democrat on the
panel. And I yield to him on his opening statement.
Chairman Luetkemeyer. Very good. We will recognize Mr.
Scott for an opening statement.
Mr. Scott. Thank you, Mr. Chairman. Thank you, Mr. Clay.
As was pointed out by the Chairman in his opening remarks,
it is important for us to remember that stress tests are an
important tool that we armed our regulators with in the
aftermath of the terrible financial crisis. And we did that so
that regulators can test the health of our country's biggest
banks.
And I was, back then, very proud of the fact that I was an
original co-sponsor of Dodd-Frank. And I am proud to say this,
that if it weren't for the most stringent capital leverage
requirements that we put in place, our financial system
wouldn't be as safe as it is today. These changes have also
made our banks more resilient. And they have led to increased
bank lending, which helped spur our great economic growth that
we are experiencing today.
These changes also have made our banks more active in
getting the necessary capital out into the marketplace. But as
I have been saying for quite a while in our numerous committee
meetings, no law is perfect. And that is to say Dodd-Frank is
not perfect.
And we, as lawmakers, cannot be unwilling to look at these
Dodd-Frank rules, simply because they are too politically
difficult to discuss. Our banking system needs us to do that.
That is why I became the Democratic leader of Mr. Zeldin's
Stress Test Improvement Act HR4293.
We have a distinguished panel. We are looking forward to
your interesting and helpful comments. And thank you, Mr.
Chairman. I yield back.
Chairman Luetkemeyer. The gentleman yields back. With that,
we go to the testimony of our witnesses. Today, we welcome the
Honorable Kevin Fromer, President and CEO of Financial Services
Forum; the Honorable Greg Baer, President and CEO of Bank
Policy Institute; Dr. Douglas Holtz-Eakin, the President of
American Action Forum; Dr. Marcus Stanley, Policy Director of
Americans for Financial Reform; and Mr. Keith Noreika, Partner
at Simpson Thacher & Bartlett.
Each of you will be recognized for 5 minutes to give an
oral presentation of your testimony. Without objection, each of
your written statements will be made part of the record. Just a
quick tutorial on the microphones in front of you. Please
pull--that whole thing will come forward. All you do is just
pull the whole thing forward. And make sure you are--the
microphone is close. It is very sensitive. Red means--or green
means go, yellow means you have a minute to wrap up, and red
means we need to close down all together.
So, with that, Mr. Fromer, your recognized for 5 minutes.
Welcome.
STATEMENT OF HON. KEVIN FROMER
Mr. Fromer. Thank you, Mr. Chairman, and Congressman Scott
and Members of the subcommittee. Thank you for having this
hearing and thank you for the opportunity to testify today.
My name is Kevin Fromer, and I am President and CEO of the
Financial Services Forum. Our members are the eight largest and
most diversified financial institutions headquartered in the
United States. And we welcome the opportunity to discuss our
support for a broad review of U.S. capital regulations, as well
as a more targeted review of the capital planning process, the
leverage ratio, and the capital surcharge which applies to only
our members.
The Forum's member firms provide vital services in support
of the U.S. economy. In the first quarter, Forum institutions
held more than $4 trillion in loans, accounting for 44 percent
of total lending to businesses and households.
Our members also underwrite nearly three-quarters of debt
and equity transactions among other large U.S. institutions,
providing critical services that other institutions cannot
provide on a similar scale.
Our institutions have significantly enhanced their
resiliency and resolvability over the past decade. And they are
strongly positioned to support economic growth throughout the
economic cycle. Notably, they maintain more than $900 billion
in tier one capital, a more than 40 percent increase since
2009.
Our member institutions also have significantly improved
their liquidity positions, holding nearly $2 trillion in high-
quality liquid assets, an increase of more than 85 percent
since 2010. Our members maintain strong capital levels, and
they support capital standards that promote both stability and
economic growth.
Since capital is a more expensive form of bank funding,
unwarranted increases in capital standards lead to increased
costs of borrowing and reduced availability of loans for
consumers, businesses and communities. To foster economic
growth, it is imperative that capital standards be
appropriately calibrated to effectively balance costs and
benefits.
Regulators worldwide have issued many new requirements at a
significant pace in recent years, necessarily focusing on each
measure individually. With nearly a decade of change and
experience and data behind us, now is the time for a holistic
review of the interaction of these important but separate
actions. Regulators here and abroad have already begun that
process of reviewing and adjusting the post-crisis regulatory
system to make key rules operate with greater transparency and
efficiency.
An important initial step in this regard was a series of
recommendations made by the Treasury Department last year. In
my testimony, we call for a broad review and highlight our
views on targeted near-term steps. The Federal Reserve, this
year, proposed to integrate its capital regulatory rule with
its capital planning and stress testing regime, while
establishing a new stress capital buffer.
In addition, two Federal banking agencies proposed to
revise the enhanced supplementary leverage ratio which applies
to only our members. These efforts, which we appreciate, seek
to maintain strong capital adequacy while reducing the
complexity, cost, and unintended consequences of the
regulations.
The Forum has offered suggestions for improving these
proposals. First, the Forum believes that the stress capital
buffer proposal should be modified to ensure that boards of
directors at financial institutions can clearly and
appropriately make capital management decisions. A firm with
capital in excess of the Federal Reserve's requirements should
be permitted to make capital distributions in the way its board
deems most productive. The Federal Reserve should also improve
the transparency of its scenario and model designs by, for
example, soliciting public comment on its stress scenarios.
Finally, the Federal Reserve should conduct full set
analysis of the effective costs and benefits of the proposed
stress capital buffer proposal that accounts for the full range
of its economic costs.
Secondly, with respect to the enhanced supplementary
leverage ratio proposal, we have recommended that the agencies
exclude risk-free assets to eliminate the economic incentive to
reduce participation in low-risk, low-return businesses.
These changes would also serve the agencies' stated goal of
ensuring that leverage requirements serve as a backstop to
risk-based capital as opposed to a binding constraint.
Finally, both the stress capital buffer and leverage
proposals import the G-SIB (global systemically important bank)
capital surcharge which, again, only applies to our members.
This surcharge was finalized in 2015, 3 years ago, in the
absence of several very important improvements to the
regulatory system.
In conjunction with our colleagues at the Bank Policy
Institute, we have analyzed the level of the G-SIB surcharge
and find that it is overstated by at least 1 percent because of
subsequent additional regulatory requirements, which both
reduce the risk and the impact of default to the financial
system.
Accordingly, we believe that the G-SIB surcharge should be
reconsidered. This is an initiative that would be wholly
consistent with the stated intent by regulators to reexamine
and reevaluate the efficacy and efficiency of the proposed
crisis regulatory regime.
We look forward to continued engagement with the Congress,
with regulators, and other stakeholders to achieve a balanced
system that seeks the goals of a safe and sound system with one
that best supports economic growth and job creation.
Thank you.
[The prepared statement of Mr. Fromer can be found on page
67 of the Appendix.]
Chairman Luetkemeyer. Mr. Baer, you are recognized for 5
minutes.
STATEMENT OF HON. GREG BAER
Mr. Baer. Thanks. Chairman Luetkemeyer and Members of the
subcommittee, today is my first testimony on behalf of the New
Bank Policy Institute (BPI). Our new organization will conduct
research and advocacy on behalf of America's leading banks,
which will also serve the interest of consumers who desire
innovative products at competitive prices and businesses who
seek funding for their growth. The stakes are high as our
members make 72 percent of all loans and 44 percent of all
small business loans.
Turning to capital regulation, U.S. banks now hold
substantial amounts of high-quality capital. Since the global
financial crisis, BPI's 48 members have increased their
collective tier one common equity from nearly $400 billion to
almost $1.2 trillion.
As a barometer for just how much capital the largest banks
are carrying in 2018, consider this year's CCAR results. I
should note that BPI's smaller non-CCAR banks have even higher
capital ratios than the largest. The scenario included a sudden
increase in the unemployment rate of 600 basis points. In the
stock market crash of 65 percent, housing prices plunged 30
percent. And a similar shock hit capital markets.
Using the Federal Reserve's own monetary policy
projections, we calculate that such a rapid increase in the
unemployment rate alone, leaving aside all the other shocks,
has only about a 50-50 chance of occurring once every 10,000
years. And yet, in this year's CCAR exercise, banks ended up
highly solvent, holding a ratio of tier one common equity risk-
based assets ranging from 4.0 to 16.2 percent.
Over-capitalization of the bank sector matters because
every major evaluation of the cost and benefits of capital
requirements, including those done by the Basel Committee, the
Federal Reserve, the Bank of England, and the IMF find, it is
lending to clients with higher capital requirements. The only
debate is how much?
Another underestimated adverse consequence of capital
regulations stems from volatility. We frequently hear from bank
CFOs that capital planning is extremely difficult when capital
requirements vary dramatically year to year, whether from CCAR
stress testing scenarios and model changes or examiner
pressure.
The final overarching concern is the credit allocation
inherent in today's regime. One bank CFO recently remarked to a
colleague that he is no longer in the banking business but
rather in the regulatory optimization business. In other words,
choosing business lines not based on the bank's own estimate of
the risk adjusted returns, but rather on how they are treated
by capital or liquidity regulations.
At the moment, the Federal banking agencies are considering
a variety of rules that could ameliorate or exacerbate these
issues. One pressing concern is how the agencies will adopt the
new CECL, or Current Expected Credit Loss, accountable
methodology for loan loss reserving.
CECL was originally proposed by the FSB as a counter-
cyclical measure. However, the strong sense of our banks, now
validated by a study we have just published this week, is that
it will have precisely the opposite effect. As a result, any
future recession will be far less, unless the bank regulators
take offsetting action.
More immediately, as 2155 revises the thresholds for
imposing enhanced prudential standards in three ways. First,
the institutions under 100 billion are no longer subject to
enhanced prudential standards, full stop.
Second, institutions between 100 and 250 billion in assets
will become exempt from most of those standards in 18 months,
unless the Federal Reserve determines otherwise by rule or
order. This review should include living wills. And, as Vice
Chair Quarles recently indicated, the LCR.
Third, 2155 requires the Federal Reserve to differentiate
how it applies any enhanced prudential standard, based on the
firm's complexity. We believe that as the Fed considers how to
implement 2155, it should suspend application of many of the
enhanced standards while it decides what to do.
I should also note the tailoring should include
international banks headquartered overseas and doing business
in the United States. Their U.S. regulation presents unique
issues as such a firm might be a G-SIB in Europe but a regional
bank in the United States. Yet, current regulation does not
consider those issues in a nuanced way.
In April, the Federal Reserve and OCC (Office of the
Comptroller of the Currency) proposed to revise the enhanced
supplementary leverage ratio. We generally support that
proposal as it would return the leverage ratio to serving as a
backstop.
We also generally support the Federal Reserve's recent
proposal to simplify capital requirements whereby any stress
capital buffer is added to a steady statement on capital
requirement, rather than being run as an annual pass/fail
exercise.
Nonetheless, we believe that before the Fed finalizes such
a proposal, it must remedy fundamental problems with its stress
testing regime and resolve significant methodological problems
with a G-SIB surcharge.
In particular, the Fed operates CCAR using a mono-model,
mono-scenario approach, which we believe produces an inaccurate
picture of risk, provides--produces unjustifiable volatility,
concentrates risk and allocates capital, principally away from
small businesses, LMI borrowers and capital markets' activity.
All in all, it is a lot for regulators in this community to
consider. We hope to help and welcome your questions.
[The prepared statement of Mr. Baer can be found on page 38
of the Appendix.]
Chairman Luetkemeyer. Thank you, Mr. Baer. Dr. Holtz-Eakin,
you are recognized for 5 minutes.
STATEMENT OF DR. DOUGLAS HOLTZ-EAKIN
Dr. Holtz-Eakin. Thank you, Mr. Chairman and Congressman
Scott and Members of the committee. It is a privilege to be
here today. I want to applaud the committee's efforts at
continuing to optimize the capital regimes that face U.S.
banks. Unquestionably, Dodd-Frank produced a better capitalized
banking sector and one that is safer, but it did so at some
fairly well-documented costs.
It is an enormously expensive regulatory initiative. It
costs about $40 billion to comply already and that tab goes up
every year. In part, because of those costs, we have seen only
a handful of new banks enter the market in the United States.
Something that I have considered a very troubling development
from the point of view of the competition in the banking
sector.
On top of that, we have seen a documented decline in the
access of small businesses to credit and that has a spill-over
impact on the capacity of those businesses to grow, to hire
people, and to provide the wages of our labor force.
At the other side of the market, we have seen a loss in
some consumer benefits, like free checking accounts. And I
think, overall, there is an increasing body of evidence that
suggests that Dodd-Frank came at too high of a cost for the
benefits that it produced.
So, I applaud the recent efforts of this committee and the
Congress in the Economic Growth, Regulatory Relief, and
Consumer Protection Act, which tailored the regulatory regime
to take some of those costs off smaller banks, which will
reverse some of the impacts that we have seen.
But I don't think that leaves us with no work left to do. I
think there are some things that I have highlighted out of my
written testimony. Number one, among the attributes that Dodd-
Frank emphasized in thinking about capital regimes was
macroprudential regulation or systemic risk issues. To my eye,
there has been no real success in identifying a good measure of
systemic risk that regulators can target and appropriately
manage.
Instead, that regime has turned into simply a second layer
of prudential regulation. I would encourage the committee to
think about holistically reviewing all of those efforts, from
the point of view of having only a single layer of prudential
regulation that actually works.
And in that regard, I want to commend the Federal Reserve
for its use of stress tests. Stress tests are a very powerful
tool to look at the capacity of institutions to weather
financial stress and economic downturns. When done well, that
is to say with a sufficient transparency, reliance on more than
a single scenario, they can accomplish great prudential
regulation by allowing the stress test to reveal the complexity
of a bank's activities in its capacity to weather those
difficulties.
So, I would encourage them to use more stress testing as a
bulwark of the regime, not less. And certainly, at least to my
eye, this has the additional advantage of bringing market
discipline as a complement to the regulatory regime.
If stress tests reveal that an institution is weak, markets
will identify that weakness. They will price it appropriately.
And they will bring pressure on that institution to correct its
capital backing. And there is no substitute for good capital to
survive downturns.
So, I think that is a place to focus going forward. And I
also think that those tests should be conducted not as part of
having the Federal Reserve tell banks how they can use their
money. They should be tested to say, is this bank sufficiently
capitalized to operate safely in the United States. And past
that, they should be able to do with whatever dividends and
other cash distributions they see fit with their money.
And so, we have made enormous progress. That progress has
come with somewhat of a price, in terms of growth and benefits
to consumers of small businesses. We can continue to make
progress and I would encourage the committee to continue to
work on that.
[The prepared statement of Dr. Holtz-Eakin can be found on
page 78 of the Appendix.]
Chairman Luetkemeyer. Thank you, Dr. Holtz-Eakin. I
appreciate your comments. Dr. Stanley, you are recognized for 5
minutes. Welcome.
STATEMENT OF DR. MARCUS STANLEY
Dr. Stanley. Thank you, Chairman Luetkemeyer and Members of
the subcommittee, for the opportunity to testify today.
Today's hearing examines capital regimes for financial
institutions. In thinking about regulatory capital
requirements, I believe it is important to start with, first,
the principles. This begins with understanding that large banks
receive extensive backing from the Federal Government.
According to the Federal Reserve Bank of Richmond's latest
bail-out barometer, almost 80 percent of the liability of all
banking institutions or $15 trillion benefits from an explicit
or implicit promise of support from the taxpayer. This support
ranges from deposit insurance to the kind of long-term
emergency assistance that was provided by the Federal Reserve
and Treasury during the financial crisis and continues to be
authorized under the Dodd-Frank Act.
Public guarantees are a cornerstone of the modern financial
system. I guarantee you that if any Member of this committee
advanced legislation that significantly cut back on those
public guarantees for the financial system, the very same
people who ask you for less regulation today would be in your
office tomorrow opposing that bill.
Given the government guarantees provided the for-profit
entities in the financial sector, it is important to require
that these private entities put up significant resources of
their own, especially by investing their own private equity
capital. In the absence of such capital requirements, companies
could take advantage of low-cost funding made possible by
guarantees--government guarantees and take the profit upside
while leaving losses to be covered by the taxpayer. That is
what we saw in the 2008 crisis.
Even with post-crisis regulatory capital requirements in
place, banks are able to borrow much more than any other
private sector business could. A private nonfinancial firm
might be able to borrow an amount equal to half its assets. An
aggressive financial firm outside the public safety net, like a
medium-sized hedge fund, would typically borrow 60 to 80
percent of the value of its assets. But the large banks at the
center of our financial system today all routinely borrow
amounts over 90 percent of their total asset value.
Simple math says that the less capital these banks are
required to invest, the greater their profit return on each
unit of equity. So, the easiest way for large banks to increase
their return on equity is to convince you, the legislators, to
reduce their required levels of capital.
To do this, they make two arguments. The first argument is
that you should be complacent. Because the current requirements
for capital and other loss absorbency are so far in excess of
any possible losses from a financial crisis that there is no
way that 2008 could ever happen again. Of course, no one
expected 2008 to happen before 2008 either.
The second argument is that you should be alarmed because
the current regulatory capital requirements impose severe costs
on the economy. Both of these arguments are mistaken. First,
you should not be alarmed. Bank lending, especially business
lending, is growing significantly faster than general economic
growth which indicates that the banking sector is not acting as
a drag on economic growth.
Capital is a resource that is actively deployed. Capital
supports lending, making lending safer and more durable. Better
capitalized banks lend more during downturns.
To the extent capital does increase bank costs, reasonable
estimates of the economic cost of increased capital are already
routinely taken account by right--into account by regulators
and setting bank capital requirements.
Multiple impartial studies show that current requirements
are, if anything, too low compared to their economically
optimal level. You should also not be complacent. While bank
loss absorbency has increased from the disastrously inadequate
levels observed before the financial crisis, it is still far
from clear that it is sufficient to fully protect against the
risk of another financial crisis. However dramatic the
microeconomic variables used by the Federal Reserve in stress
test scenarios, the underlying stress test models that project
scenario losses are still showing estimated loss is much less
than those actually experienced by banks during the financial
crisis.
And most of all, you must not be complacent because of the
devastating economic impacts of financial crises. The last
crisis produced some--created some $10 trillion in direct
economic cost to the U.S. alone. Nine million lost jobs.
Millions of families foreclosed from their homes. And shook the
legitimacy of both our economic and political system. It must
not be permitted to happen again.
[The prepared statement of Dr. Stanley can be found on page
101 of the Appendix.]
Chairman Luetkemeyer. Thank you, Dr. Stanley. Mr. Noreika,
you are recognized for 5 minutes. Welcome.
STATEMENT OF KEITH NOREIKA
Mr. Noreika. All right. Mr. Chairman, Ranking Member Scott,
and Members of the subcommittee, thank you for having me here
today. During 2017, I had the honor to serve as the Acting
Comptroller of the Currency. Today, I hope to give you my
perspective as someone recently familiar with both the concerns
of the public and private sectors.
I will focus my remarks on the need for tailoring two
important segments of the financial system. First, regional
banks with between $100 and $250 billion in total consolidated
assets. And, second, international banking organizations that
have a banking and capital markets presence in the U.S.
In Dodd-Frank, Congress stated that the Federal Reserve,
quote, ``may differentiate among companies on an individual
basis by category, taking into consideration their capital
structure, riskiness, complexity, financial activity, size and
any other risk-related factors.''
Despite this invitation to tailor, the vast majority of the
Federal Reserve's enhanced prudential requirements have been
applied to all firms based on simple asset measures. In a
recent enactment of the regulatory relief legislation in May,
Congress has now directed the Federal Reserve to tailor its
requirements to the riskiness of the institutions that it
supervises.
With respect to regional banks, the Act first presumes that
all firms with less than $250 billion in total consolidated
assets are no longer covered by enhanced prudential
requirements. And to apply them, the Federal Reserve must
affirmatively demonstrate that the requirements are appropriate
to prevent risks to financial stability or to promote safety
and soundness, and there have been no such risks currently
identified for such firms.
Second, the Act requires that the application of any
enhanced prudential requirement to a firm with at least $100
billion in total consolidated assets must take into account a
statutory multi-part conjunctive test. Third, Congress has
required separate analyses for assessing the application of
each enhanced prudential requirement.
And, finally, as the Federal Reserve proceeds to implement
the Act, the substantive requirements of each of the enhanced
prudential standards should also be revisited, reexamined, and
tailored to ensure that the substance of each requirement is
appropriate based on the risk posed by the subject firm.
With respect to the application of enhanced prudential
requirements to international banking organizations, since the
passage of the International Banking Act in 1978, the
regulation of international banks operating in the U.S. has
been guided by a nondiscrimination principle of, quote,
``national treatment and equality of competitive opportunity.''
Congress' commitment to national treatment was reaffirmed
in Dodd-Frank. The implementation of enhanced prudential
requirements has not always lived up to Congress' mandate of
national treatment, most notably through the implementation of
an intermediate holding company requirement on firms with more
than $50 billion in U.S. non-branch assets; and a variety of
prescriptive governance, risk management, capital, liquidity,
stress testing, and resolution planning requirements on the
U.S. operations of international banks.
The U.S. ring-fencing requirements and reactive foreign-
ring fencing requirements cause a net increase in capital costs
on international firms and U.S. firms operating abroad as
countries apply stand-alone capital and liquidity requirements.
This may have the perverse effect of making banks with cross-
border activities less safe because if a crisis in one
geography burns through the firm's local prepositioned
resources, the firm may be precluded from using its resources
located elsewhere to bolster the part of its operation under
stress.
There are a number of actions that the Federal banking
agencies should take to reintroduce national treatment into
their regulation of the U.S. operations of international banks.
First, the agencies should better account for the global
resources of international firms when calibrating capital,
liquidity, and stress testing requirements applied to the U.S.
operations of these firms.
Second, consistent with the June 2017 Treasury Report
recommendations, the requirements applicable to the U.S.
operations of international banks should be commensurate with
the risks posed by their U.S. footprints.
Finally, the current CCAR framework disadvantages
international firms, whose U.S. operations are primarily
capital markets in nature and does not take into account the
benefits of global diversification that exists for these
international banks.
Thank you and I look forward to your questions.
[The prepared statement of Mr. Noreika can be found on page
84 of the Appendix.]
Chairman Luetkemeyer. Thank you, Mr. Noreika. I appreciate
your testimony today and all of the gentlemen here that are on
our panel today.
With that, we will begin the questioning. I will recognize
myself for 5 minutes.
I guess, Mr. Noreika, we can start with you. With regards
to implementing Senate Bill 2155, do you see any ambiguity in
the way that the $250 billion threshold was set?
Mr. Noreika. Could you repeat that?
Chairman Luetkemeyer. Yes. Do you see any ambiguity in the
way that the $250 billion threshold was set or is the statute
pretty clear?
Mr. Noreika. I think the--yes. No, thank you.
Chairman Luetkemeyer. Because you were talking about this
in your statement here just now and talking about concerns on
how this should be done. Have you seen any concerns at this
point with it not being done?
Mr. Noreika. Well, look, I think the statute is clear. The
statute presumes that these banks are out unless a
determination is made, both that there is a risk of financial
stability of the United States or safety and soundness of the
institution. And a multi-part statutory test is applied to each
prudential standard to reapply to those banks.
Now, I think we heard from the Chairman of the Federal
Reserve today in his testimony, in an exchange with Senator
Warner, that they are working on this. And I think the effort
is to urge the Federal Reserve to apply the statute as it is
written to, I think, immediately lift the enhanced prudential
requirements on these banks until and unless they can
empirically demonstrate that there is a need for each of the
prudential requirements to apply to each of the institutions in
this asset range.
Chairman Luetkemeyer. Well, and I know the procurement
period on this is disclosed. And I am sure they are listening,
so has anybody got a comment they would like to make to the Fed
that say, hey, we suggest this? Nobody has a comment to make to
the Fed today? Really? OK. I have a lot of them. But we will
stop there.
With regards to--Dr. Holtz-Eakin, you were talking about
the stress test and the importance of it. And I think you made
a comment, something to the effect that it was--you don't think
it is quite as good as it could be because it doesn't quite
accurately measure the stress that banks are under. Can you
elaborate a little on that?
I would agree with you, probably to a point. You can't--it
is difficult to guess what kind of stress can come--where it
can come from and all of the different variables so who knows
what is going to happen. But what would you see as some extra
things that the Fed could do or perhaps, that we could do to
enable this to be a better situation?
Dr. Holtz-Eakin. So, I think there are really two areas.
The first is the transparency and the public nature of the
information revealed by the stress test. If you think back to
the first stress tests when they were done, the original plan
was not to make the results public. And markets were in turmoil
and there was an enormous amount of fear and uncertainty.
And when they decided to actually reveal those stress
tests, it allowed market participants to identify healthier
versus less healthy institutions pretty clearly. It allowed
them to price those risks more effectively. And it allowed them
to bring market discipline to the operation of those banks. It
is important that that continue going forward.
I am concerned, my comment to the Fed, about this plan to
simply move away from having stand-alone stress tests, put
everything into a CCAR process that doesn't look terribly
transparent to me. I think that is giving up the opportunity to
have market discipline as a complement to good regulation. And
you need both. So, that is point number one.
The second point is, I am not a big fan of a single
scenario stress test. Stress tests are done by lots of
institutions for their own purposes and they involve multiple
kinds of scenarios to test, genuinely, their exposure to
different kinds of downturns, different kinds of commodity
price fluctuations, different kinds of housing market impacts.
I would encourage the Fed to think more about bringing that
kind of a regime into play.
Chairman Luetkemeyer. Well, along that line, Governor
Tarullo in my comments, I indicated that he made the comment
that stress testing programs should move to the normal
examination cycle. And, to me, I think that is where it needs
to go. I don't know if the banks need to be filling out forms
to have the regulators see if they have guessed right on
whether this is actually going to work.
To me, the regulators should have a set of scenarios that
they believe could happen. They go into a bank and they apply
those scenarios to the business model and the actual bank
members and see if it works. Is that something that makes sense
to you?
Dr. Holtz-Eakin. I whole-heartedly concur. I think that is
exactly the right way to use them. And reveal those results and
that would be a good way to do prudential regulation. In the
end, you want good safety and soundness regulations and stress
tests can be an important part of that.
Chairman Luetkemeyer. My time has almost expired. With
that, I will yield back the balance of time and I will go to
the distinguished gentleman from Georgia. Mr. Scott is
recognized for 5 minutes.
Mr. Scott. Thank you very much, Mr. Chairman. Mr. Baer, let
me start with you. I wanted to ask your thoughts--ask you for
your thoughts on stress tests because, as I mentioned earlier
in my opening remarks, my bill with Mr. Zeldin makes structural
changes to the stress test regime in the--in this way. Our bill
made such structural changes as saying the Fed couldn't fail a
bank for their qualitative portion of their test. And we also
eliminated the adverse scenario from the test requirements,
among other things.
But recently, from the Fed, as we all saw for the first
time, handed out a passing grade when a passing grade wasn't
deserved. The Fed referred to this as, quote, ``a conditional
nonobjection'' It is interesting to know what that means.
But I also view the amendments we made in my bill with Mr.
Zeldin as a way to reduce the burden without fully gutting
these critical, important tests. But I viewed these recent
actions from the Fed as a way to smooth out our markets
negative and often overly harsh a reaction to the news of a
bank receiving a Federal grade.
So, Mr. Baer, let me ask you this first part. What sort of
reforms do you think are more important?
Mr. Baer. I would--thank you, Congressman. I would agree
with you that the qualitative portion of the CCAR should be
part of the regular examination process just the way they
examine anything else from credit underwriting to the markets'
businesses. The adverse scenario is proving useful because it
simply never binds and it has just become an exercise that does
not have a lot of benefit and is probably not as robust as some
of the scenarios that Dr. Holtz-Eakin was talking about that
the bank, itself, runs.
With respect to the results and pass or fail. I think where
we need to get is where we have confidence that those results
are actually meaningful and where the Fed can be comfortable
saying there is really no way to give an exception.
Right now, and I think you have already heard it, we are in
a mono-scenario, mono-model world where you have extreme
stresses in certain areas and level stresses in other. That is
not necessarily the result that is going to--or the process
that is going to--that is going to make the banks safest. Banks
should not just be testing for, and I assure you they do not,
very high increases in employment. They should be looking at
what happens if there is a problem with foreign debt, something
in China, something in Russia, European issue, hyperinflation,
deflation.
So, banks that are really managing their risk, they look at
all those different scenarios and then they make a judgment
about what their capital needs are. And so, we support the
notion of the Fed running multiple scenarios, perhaps averaging
them--averaging them over time, expressing the volatility.
Mr. Scott. Very good. Now, Dr. Holtz-Eakin, I hope I
pronounced your name correctly.
Dr. Holtz-Eakin. Exactly right, sir.
Mr. Scott. Thank you. You made some interesting comments in
your testimony. First of all, you said that competition in the
banking system is getting less. You said there are fewer and
fewer banks. You said there are fewer and fewer checking
accounts at these banks. You also said systemic risk regulation
is now questionable.
And then you said this. You said, we need more stress
testing and not less. Now, we have five distinguished gentlemen
there. How many of you agree with Mr. Eakin that we need more
stress testing, not less? All right, we have two out of three?
Tell me, give me--those of you--somebody--one of you who
disagree, tell me why? Why do you think--now, Mr. Eakin has
said why we need more. One of you that raised your hand said we
need less. Tell me why you disagree. Yes, Mr. Fromer.
Mr. Fromer. Yes, I will start. Let me just say that the
issue is not the stress test, per se, because the stress test
process is a useful process. The issue is parts of the process
that have proven to be not transparent, whether it is the
models, as Mr. Baer has referred to, or the economic scenarios,
that Mr. Holtz-Eakin has referred to. So, the improvements that
we believe are necessary are focused on the transparency of
both of those components of the stress test.
So, it may involve more scenarios as they have discussed.
But I think it is the quality of the scenarios and the
understanding of what is inside the model of the Federal
Reserve versus the real experience of the institution itself?
And then, the quality of the actual economic scenarios. Are
they extreme? Are they plausibly extreme? And when do the firms
experience that information for purposes of their capital
planning, in order to reduce the volatility that has been
mentioned?
Mr. Scott. All right, very good. Thank you, Mr. Chairman.
Chairman Luetkemeyer. Thank you. The gentleman yields back.
With that, we go to the Ranking--or the Vice Chairman of the
committee, Mr. Rothfus. The gentleman from Pennsylvania is
recognized for 5 minutes.
Mr. Rothfus. Thank you, Mr. Chairman. Mr. Baer, as you
know, Basel III takes a fairly punitive approach to mortgage
servicing rights compared to other intangible assets. This is
particularly challenging for U.S. banks since our mortgage
market relies on securitization while banks in other
jurisdictions tend to follow the originate-and-hold model.
Can you describe how Basel III's approach to mortgage
servicing rights affects U.S. banks?
Mr. Baer. Sure. Thank you, Congressman. Now, clearly, there
was a very large change made post-crisis to mortgage servicing
rights. The level at which a capital deduction occurred, the
threshold was much lower. And then, the capital deduction, I
think, rose from 100 percent to 250 percent. So, it is a
substantial penalty.
It is also interesting that that came out of the Basel
Committee where, really, it is the United States. This is
really a uniquely U.S. issue so--because we have a large
securitization market. And I think it is fair to say that most
countries around the world don't really have this issue as
much. So, that may not have been the best place to have it
debated.
It is fair to say that during the crisis, mortgage
servicing rights did not become a readily salable asset. So,
clearly, there should be some restrictions on their ability to
count toward capital. And I think it is a very good question
whether the post-crisis reaction that came out of Basel was too
extreme.
And yet, I think it would be a very good idea to
recalibrate that. And, almost certainly, downward to give more
credit for it. Certainly not as much credit as common equity.
But more--I think it is now five times the capital deduction
for residential loans.
Mr. Rothfus. Well, can you offer some insights on how
capital rules applicable to mortgage servicing rights affect
the consumers?
Mr. Baer. Sure. Well, it affects consumers in two ways.
One, it increases the cost of the servicing. But, also, what
you have seen post-crisis, as a result of the very high capital
charge, is that a lot of this business has migrated away from
regulated banks to nonbank servicers.
I think there was a time when that was considered to be a
good thing. I think experience has taught us that consumers are
probably better off if that is at a regulated financial
institution with a lot of other relationships with that
customer and a lot of incentives to do right by that customer.
Mr. Rothfus. Mr. Fromer, over the last decade, the Federal
banking agencies have built a complex regulatory regime with
wide-ranging consequences for regulated industries and the
broader economy. While our committee has led the way on
historic regulatory reform, we should all recognize that there
is always an opportunity to build a stronger and more efficient
regulatory system. In order to do that, we need an honest and
thorough account--thorough accounting of the rules in place
today.
In a speech earlier this year, Vice Chairman Quarles said
the following. Quote, ``now is an eminently natural and
expected time to step back and assess past regulatory efforts.
It is our responsibility to ensure that they are working as
intended and given the breadth and complexity of this new body
of regulation, it is inevitable that we will be able to improve
them, especially with the benefit of experience and hind
sight.''
Do you agree with the--do you agree that the Fed should
undertake a holistic review of our regulatory regime and, if
so, why would this be important?
Mr. Fromer. Thank you for the question. First of all, I
would wholeheartedly agree with that statement. And I believe
it is a statement that is at least conceptually shared, not
only here but amongst regulators outside the U.S. And that is
to say, after you have a decade of experience in data, not only
amongst the regulators but the firms themselves, that you--that
the responsible thing to do here is to take a holistic
approach.
As perfect example of why you need to do that, we have
something called the G-SIB surcharge that applies to the Forum
institutions. That G-SIB surcharge is put in place for the
purposes of putting capital into the system, in the event that
there is a heightened risk of default or failure of a large
firm and the impact that could have, the social cost that could
have.
But it was put in place at a time when a series of other
improvements had not been implemented. Those improvements have
been implemented. And as a consequence, the surcharge is, to
some degree, redundant of the improvements that have been made.
So, that is an example of the kinds of things that, I
think, the regulators need to take a broad look at in the
context of the framework.
Mr. Rothfus. Mr. Noreika, in your testimony, you wrote that
regulators should be transparent in rulemaking and supervisory
process and not become overly reliant on unofficial rulemaking
through guidance. Of course, this backdoor approach to
regulation was all too common in the previous Administration.
You recently finished a stint as the Acting Comptroller of
the Currency. Have you seen a shift in the attitude and actions
of regulators in recent months on this topic?
Mr. Noreika. Well, I have, Congressman. And I think it is a
welcomed change. And I think we are starting to see some of
this reviewed by Congress as a congressional Review Act, such
as we saw with the indirect auto lending guidance. And I think
there is an effort underway at each of the banking agencies to
catalogue their so-called guidance and see what needs to be put
out for notice and comment. And then, also, what might be
subject to a congressional review as well.
So, I think it is a welcomed guidance. I think rules will
get more rules, which will get more rules in how they are
implemented. And guidance, obviously, is useful up to a point
but it has to remain guidance. And when it becomes a binding
effect, then there are certain legal protections that are there
for the--for those that are regulated and that has to be--the
government has to be mindful of that.
Mr. Rothfus. My time has expired. I yield back.
Chairman Luetkemeyer. The gentleman's time has expired. I
call the gentleman from Texas who is recognized for 5 minutes,
Mr. Green.
Mr. Green. Thank you, Mr. Chairman. I thank the witnesses
for appearing as well. I remember when we were talking about
long-term capital. Anybody remember that name, long-term
capital? You--OK, thank you. And we were talking about events
and how things just couldn't happen. But before there was long-
term capital, we had people who were very skeptical about
regulations. And nobody anticipated that long-term capital
would occur but it did.
I remember when the banks would not, NOT--would not lend to
each other. And I remember why we had to resort to Dodd-Frank.
Dodd-Frank was necessary and, in my opinion, it has served us
well. I think the living wills, the stress tests are important.
For a multiplicity of reasons, I might add.
But we have two persons who have indicated that they think
we should have more stress tests and didn't get a chance to
hear your responses as to why. So, let me start with the first
person who would like to respond. Which of you will that be,
please?
Mr. Baer. I will go. It is a very broad question. I think
for firms that are subject to stress testing, and I think that
should include large complex firms, those that have a variety
of businesses perhaps internationally, you are always going to
be better off running more stress scenarios rather than fewer.
You don't want them only preparing for one type of impact as
opposed to a variety. That is not to say, though, that for
every firm, stress testing is appropriate.
And I believe Congress got it right in 2155 when it moved
from annual periodic with respect to regional firms. Those are,
generally, firms that have a pretty homogenous book of mortgage
loans, C&I (commercial and industrial) loans, generally not any
international exposure, probably have a more complex liability
structure.
So, I think it really varies, depending on the bank. But
once you are saying, yes, stress testing is appropriate for
this bank, I am very worried about the current regime where you
have a mono-model, mono-scenario approach to determining the
capital adequacy of that bank.
Mr. Green. Mr. Stanley, I think you were among the two.
Dr. Stanley. Yes, I think what is going on here is that I
agree, conceptually, with Dr. Holtz-Eakin and Mr. Baer that
there are a wide variety of types of stresses and stress
scenarios that could impact a bank. And regulators have to be--
both regulators and banks have to be creative and aggressive in
seeking out what might be on forecast risks or risks that are
difficult to forecast that might harm the bank.
So,you have to test a greater range of scenarios. But I
would just point out that this goes, in my view, completely
opposite to this claim by industry that we can't have
volatility in stress testing results, and stress testing
impacts and stress tests can't change from year to year. The
very fact that markets change so often that you have to check
multiple scenarios, to me, means that there should be an
unpredictable element in stress tests. They should change.
And if you have had a stress test that was totally
predictable, it wouldn't really be stressful and it wouldn't
really be a test.
Mr. Green. I think that I see someone who would like to
respond to your response so I will yield to you. And give your
name, if you would. Is it Mr. Baer?
Mr. Baer. Yes.
Mr. Green. Thank you.
Mr. Baer. I think to the extent that markets are actually
changing, bank's capital requirements should change. If all
that is changing is the stress test that is chosen by the
regulator, that really shouldn't be causing large changes in a
bank's capital position.
It is important because banks have to make long-term
business plans: 1, 2, 3, 5 years out. And if you don't know
what the capital charge is going to be for that business, it is
very difficult to do that. And that does not help consumers or
businesses.
Again, if there is a real change in the bank's risk, yes,
and it is to the upside, the bank's capital prime should go up.
If it is--if it is to the downside, it should go down. And this
doesn't necessarily mean, I would say to Dr. Stanley, lower
capital requirements. To the extent that you average them,
either averaging a variety of scenarios or averaging the
results over a couple of years or whatever that stress scenario
is, that would still suppress volatility. It wouldn't really
necessarily--
Mr. Green. I think Mr. Stanley would like to have a final
retort so I am going to allow this debate to continue for this
last round. Mr. Stanley.
Dr. Stanley. Well, I have very little time but I guess I
would just point out that we--in terms of capital planning and
long-term planning, we actually don't want banks over-adjusting
and trying to track the regulatory capital requirements. We--
that element of unpredictability, I think, could be important,
precisely so that banks don't take excessive account of
regulatory requirements in their future planning, and instead
look more at the business environment.
Mr. Green. Mr. Chairman, if I may, Ranking Member Clay has
asked that I offer some materials for the record with unanimous
consent.
Chairman Luetkemeyer. Without objection.
Mr. Green. The Center for American Progress has a rather
lengthy document and letter to be submitted; Better Markets
similarly situated; the Americans for Financial Reform. I ask
that, if there are no objections, that all be submitted into
the record.
Chairman Luetkemeyer. Without objection.
Mr. Green. Thank you.
Chairman Luetkemeyer. The gentleman's time has expired.
Now, we go to the gentleman from Oklahoma. Mr. Lucas is
recognized for 5 minutes.
Mr. Lucas. Thank you, Mr. Chairman. And I would like to
revisit a couple of issues with my colleagues here. But first,
I always remind folks that coming from a capital-starved
region, the oil and gas industry, agriculture, Main Street in
rural Oklahoma, capital is always a challenge for us. By the
same token, I acknowledge to you that I come from a long line
of debtors, so I have a certain perspective from that
perspective.
Let us visit Mr. Baer. I have heard my constituents, in the
wake of S2155, say that they are confused about legislative
intent when it comes to stress testing. Some of my banks, most
of which are very small and are well under the $100 billion
threshold, believe that 2155 was meant to do away with all
stress tests for banks under those numbers, not just the test
called for in Dodd-Frank. I realize you don't speak for FDIC,
but is this a view that is widely shared by--among the
industry?
Mr. Baer. Yes. I think, Congressman, that if you are under
that threshold, it is the assumption and the only way I would
read the statute is that that is the end of having to do these
types of stress tests. And I would say we are actually quite
concerned that regulators these days are very fond of what we
call horizontal reviews, which we sometimes call examinations
management consulting, where they will look at a variety of
banks and come in and say, you know what? We don't like your
practices. We want you to do what some other banks are doing.
So, to the--we are very concerned that these same
requirements that have been ended by 2155 will actually come
back in through the examination process. And I really think
that is something for this committee to keep an eye on.
Mr. Lucas. That was my next question: How we clarify the
situation so that the intent behind 2155 is obvious to
everyone.
Mr. Baer. Again, Congressman, I think it is a real concern.
We have a whole--we could have a whole separate hearing on the
examinations as far as the regulatory process. Because I think,
particularly for smaller banks, a lot of this isn't about
stress testing or G-SIB surcharges or any of that. It is really
about a fundamental shift, post-crisis, away from examinations
focusing on safety and soundness issues that are material to
the health of the firm and toward more minor criticisms and
consulting and horizontal reviews.
I do think it is going to be a long process. But I hope
that the new leadership of the agencies can refocus the exam
teams on matters that are material to the financial institution
and not just wanting them to do it a different way.
Mr. Lucas. So, you don't disagree. When the bankers say
they read what they read which is how I read the bill. It
sounds like the way you read the bill.
Mr. Baer. Yes, that is what I understand. I think Mr.
Noreika eluded to guidance where, for years now, banking
agencies have been issuing guidance. And they say it is only
guidance but every banker you talk to, every compliance
department says, no, we treat that as a binding regulation in
every case because that is the way the examiners treat it. So,
it is a cultural thing. I think it is going to be difficult to
resolve but it is an important issue.
Mr. Lucas. Mr. Noreika, let us touch on that subject of the
issue of mortgage servicing rights and the treatments under the
capital rules. I have a couple of constituent institutions in
Oklahoma that have been very successful in servicing things
like FHA loans. There other institutions across the country
that are very successful in dealing with V.A. and USDA loans.
And they are very concerned, as we have discussed earlier,
that under the Basel III cap, combining with the risk of these
assets hinders their ability to engage in the activity, and
they tell me that they are seeing literally the business being
driven to nonbank lenders where their regulation is lighter.
Could you touch on that for just a moment? Is this a
legitimate concern by my constituents?
Mr. Noreika. Yes. And it is something that I faced at the
OCC and we put out a proposed rule that hasn't yet been
finalized. But certainly the capital charges for servicing
rights are overly punitive. It disproportionally impacts
regional community banks and reduces the availability of loans
in our communities. Holding mortgage servicing rights is often
part of a sound strategy for banks that originate and sell
loans while retaining the right to service these loans.
The practice permits banks to make loans in our community
and develop stronger customer relationships while appropriately
managing risks to their balance sheets.
As I mentioned, when I was at the OCC, we put out a capital
rule to streamline and loosen the punitive requirements on
these requirements in, I believe, September 2017. I think the
time has come for the agencies to finalize that rule, with
respect to mortgage servicing rights, and take away some of the
punitive effects that comes from holding these assets.
Mr. Lucas. Thank you, sir. I yield back, Mr. Chairman.
Chairman Luetkemeyer. The gentleman yields back. With that,
we go to the distinguished gentleman from Kentucky, Mr. Barr.
The Chairman of the Monetary Policy Committee is recognized for
5 minutes.
Mr. Barr. Thank you, Mr. Chairman. I will start with Dr.
Holtz-Eakin. The question about the legislation that was
recently signed into law, Economic Growth, Regulatory Relief,
and Consumer Protection Act. What do you believe will be some
of the most pronounced impacts on bank lending, now that that
law has been signed?
Dr. Holtz-Eakin. I think the most pronounced impacts are
going to be in the relatively small loans: $50,000, $100,000,
$200,000 to small businesses in the area--in those areas. We
know there has been a big geographic dispersion in the quality
of the economic recovery. It looks a lot like the geographic
dispersion in the access to credit. And so, I think that is an
important economic benefit.
Mr. Barr. Can you elaborate a little bit more on your
testimony about market discipline as an additional factor in
strengthening the financial system, in addition to capital
requirements?
Dr. Holtz-Eakin. There is nothing better than capital for
honing incentives, right? The thought of losing your own money
is a powerful motivator. And if you have investors who are
looking at institutions carefully and correctly trying to price
the risks that those institutions face, that is a tremendous
source of discipline to the operation of those institutions.
So, wherever possible, it is useful to try to bring that
into the process. And that is one of the reasons I, at least,
think that the stress tests are so valuable. They provide
information to market participants about how firms react in
different situations. That is useful for pricing.
Mr. Barr. Is there a lack of transparency anywhere in the
law right now that could be corrected, in terms of transmitting
greater levels of information to consumers?
Dr. Holtz-Eakin. I just echo a lot of the things that Mr.
Baer said about the current stress testing regime not having
sufficient robustness to convey all of the risks that these
institutions will face and can weather or not weather. And that
is what you want to know.
Mr. Barr. Mr. Noreika, thank you for your service at the
OCC. And let me just ask you, now given your background in both
the private sector and the public sector, your thoughts about
the role and importance of regional banks in the traditional
lending model and how does over-regulation contribute to
curtailing lending in economic growth?
Mr. Noreika. Well, thank you, Representative Barr. Look,
failing to properly tailor the enhanced prudential
requirements, with respect to regional banks or all banks, will
continue to increase the price and limit the availability of
credit in the United States and, ultimately, stifle economic
growth. Poorly tailored requirements also hurt access to
credit, usually for those at the margin, those in underserved
communities which are often served by regional banks. Poorly
calibrated requirements also unintentionally incentivize
unnatural and risky behavior and they make the market less
safe.
Mr. Barr. Can I jump in really quickly?
Mr. Noreika. Yes.
Mr. Barr. Your--the thrust of your testimony was that the
$50 billion asset threshold was an arbitrary threshold.
Mr. Noreika. Yes.
Mr. Barr. And that the new regime is a preferred approach,
based on these multi-factor tests.
Mr. Noreika. Yes.
Mr. Barr. The presumption is that if a--if an institution
has assets less than $250 billion, it is--it doesn't warrant
that enhanced prudential supervision. But it does give
discretion above 100 billion for that--for the application of
those enhanced supervisory rules.
What is so--what is magic about the $250 billion threshold?
Is there an argument to be made that that threshold should go
up as long as the regulators have the discretion to apply a
similar multi-factor test to institutions between, say, 250 or
500 billion or, for that matter, any institution that is not
categorized as a G-SIB.
Mr. Noreika. Sure. That is a very good question. Look, I
think the way the world is divided now, in light of the
regulatory relief legislation, is that everything under 250
billion is presumed to be out. And everything under 100 billion
is absolutely out by statute.
Above 250 billion, Congress now has required, directed the
Federal Reserve to apply its enhanced prudential standards
based on this multi-par test. One of those factors is asset
size. But the other factors are not asset size. And so, even
for the banks above $250 billion, the Federal Reserve has to go
back and they have to look at each of their--and it says any
prudential standard so it is for each one. They have to look at
them and they have to look at the--those factors with respect
to the individual institution.
And I think this dovetails nicely with what we are hearing
out of the new leadership of the Federal Reserve as far as
tailoring goes. Congress has provided a roadmap for tailoring.
Mr. Barr. I have more questions but my time has expired.
Thank you.
Mr. Noreika. Thank you.
Chairman Luetkemeyer. The gentleman's time has expired.
With that, we will go to Mr. Tipton. He is from Colorado. He is
recognized for 5 minutes.
Mr. Tipton. Thank you, Mr. Chairman. I thank the panel for
taking time to be able to be here. And Mr. Noreika, maybe you
would like to go back a little bit more, in terms of some of
the questions that Mr. Rothfus had brought up, in regards to,
are we actually seeing the needle move after 2155 is being
signed into law with the regulators. Some of the comments that
I have had from some of my local banks is when--you were just
talking about some of the tailoring end of it.
Mr. Noreika. Right.
Mr. Tipton. They said they really haven't seen any real
impact. It is business as usual. So, could you drill down a
little bit more in where you are seeing that movement starting
to go?
Mr. Noreika. Sure. And, look, I am on the outside looking
in now. And I was recently on the inside looking out. I don't
disagree with your statement. I think that Congress has
provided fairly clear guidance to the agencies.
I think that the agencies did take immediate steps for the
banks below $100 billion to inform them of certain changes.
Maybe that hasn't filtered out entirely. But I think that
whatever those are, they should be in constant contact with
their regulator to work out those issues because what Congress
did was fairly clear.
I think the real issues immediately facing the agencies are
with below 250 billion, this presumption that they are out,
unless there is a finding made that there is a threat to
financial stability or safety and soundness and the application
of a multi-par test. And then, above 250 billion, there is the
application of the statutory multi-par test that now is
directed by statute. And I think that is one we haven't yet
seen the agencies come out and talk about. And hopefully we
will soon.
But I do have an appreciation for the way things work in
the public sector as opposed to the private sector. I suppose 2
months in the private sector--in the public sector isn't quite
as fast as perhaps I would like. But--or you would like.
But I am sure they are working on it diligently. And I
think hearings like this help give valuable input on helping
them to come to a formulation of how they are going to deal
with these different groups of banks.
Mr. Tipton. Right. And I think Mr. Barr's comments in terms
of setting arbitrary thresholds and how that impacts. Do you
have some recommendations specifically rather than just having
arbitrary thresholds? I know they are working on it. But is
there something more that Congress could be doing?
Mr. Noreika. Well, look, I think you are doing exactly the
right thing like holding hearings like this. And I think you
can step in with targeted legislative actions if the agencies
go in the wrong direction or read the law the wrong way. Hold
their feet to the fire. And that is exactly what you should be
doing.
I think right now, the goal is for the agencies, and with
congressional direction, to go reexamine everything they did
before. And so that not only is the scope, but also the
substance as well.
I think you have to also look at each of the requirements
and see whether they are narrowly tailored or whether it is a
broad-brush approach to applying something to one of the
largest banks, then being falling downhill, if you will, as I
think Senator Corker once told me toward the Main Street banks
and having an overly punitive effect which has ramifications
for the economy.
Mr. Tipton. Mr. Baer, would you like to comment a little
bit on this? And I thought it was interesting, you were making
the comment regards to some of the horizontal type of
examinations that are going on. And I came from the private
sector and we were constantly doing a review in business,
almost every day, had the flexibility, the nimbleness to be
able to make some changes, if necessary to be able to do it.
Would you address some of that regulatory process?
Mr. Baer. Sure, Congressman. It is actually quite--I think,
quite interesting, from a bank regulatory policy perspective.
That clearly, and I think they would agree post--in recent
years, the Fed and the OCC are going in opposite directions, in
terms of how they examine. The OCC is reemphasizing the
importance of the examiner in charge and having a resident team
that knows and understands that bank.
The Federal Reserve is moving toward a more centralized
approach with cross-reserve bank, cross-functional teams and a
lot of folks in Washington. I could actually make a good
argument for or against either approach. I think either could
work, either could fail.
But I do think the risk of the latter approach is that you
get to having the cross-functional team as, sort of, judge and
jury. Where they are looking at multiple banks and they are
picking the one they like the best.
I have heard this from multiple firms that they were told,
well, yes, on the liquidity front, you are in compliance with
the OCR. You passed CLAR. Your own work is pretty good. But we
just completed a horizontal review, and we like what somebody
else is doing better.
Will we give you access to that? No, we will not. That is
confidential supervisory information. But we would like you to
up this or change this. And I think that is very unfair to the
banks and also I just think it is a bad idea.
There are real benefits--ultimately, banks compete on the
ability to manage risk. And if you can have all banks manage
risk the same, obviously that is something of an overstatement.
But to the extent that you are pushing back some to measure
risk the same way and manage it the same way, that is not a
great thing.
Mr. Tipton. Thank you. My time has expired, Mr. Chairman.
Chairman Luetkemeyer. The gentleman's time has expired.
With that, we have the Ranking Member has returned. And with
that, we recognize him for 5 minutes' worth of questions. Mr.
Clay.
Mr. Clay. Thank you, Mr. Chairman. And Dr. Stanley,
regulators under the Trump Administration have said that since
it has been a decade since the financial crisis, and it is time
to review and revisit all of the post-crisis financial rules to
seek improvements, what is your early assessment of their
proposals? Are their proposed modifications to post-crisis
reforms one-sided with the focus on deregulating the financial
industry?
Dr. Stanley. Well, you answered the question for me. They
absolutely are one-sided. And we have no problem with
reviewing. We do believe that it is entirely appropriate to
review our regulatory framework.
But this is a review that seems exclusively focused on
weakening the regulations that came out of the financial
crisis. And, in fact, in several cases, we had proposed rules
that were ready to go, that would have strengthened regulation,
regulation of bonus--bank bonuses, regulation of commodity
activities at banks. And these rules were just dropped as
though they never existed because they didn't go in that
deregulatory direction.
Mr. Clay. Yes. And do you think lessons from the financial
crisis have faded in the minds of some policymakers? I know
that when I look at the housing market, just like African-
American borrowers were steered into high-priced loans for no
reason other than the complexion of their skin, that now we
have reverted back to that. That there is still a
disproportionment--disproportionate number of people who are
applying for 30-year mortgages that are being denied. Do you
think those memories have faded already after 10 years?
Mr. Stanley. Well, I think that memories may have faded in
Washington D.C. I don't think that memories have faded outside
of Washington D.C. Middle-class wealth is still significantly
lower than it was before the financial crisis. Are the impacts
of financial crisis, in terms of loss of housing, in terms of
increases in poverty have not really--are still with us outside
of Washington D.C.
Mr. Clay. Yes. Do you believe the Fed failed, as many of us
do, at implementing and enforcing our consumer financial
protections lost prior to the creation of the CFPB (Consumer
Financial Protection Bureau)?
Dr. Stanley. Well, I think it is very clear that the Fed
failed. The Fed was warned and the Fed did not take action on
predatory subprime lending, on predatory lending that targeted
minority communities. And in the case of the OCC, we had the
OCC actively stepping in to preempt and reverse State laws that
would have taken action against some of this predatory lending.
So, they were actually weighing in to expand predatory
lending. And that is why it has been so important to create an
independent consumer agency.
Mr. Clay. And then, they knew the Countrywides and the
other predators were out there preying on consumers and they
enhanced it and helped them. Unbelievable.
Was it important to impose enhanced prudential standards on
the Nation's largest banks as Dodd-Frank did, including
requiring more capital, less leverage and regular stress tests?
Dr. Stanley. Well, I--absolutely. Things went terribly
wrong before the financial crisis. You had entities, weeks
before they failed, reporting that they were perfectly fine and
they exceeded regulatory capital requirements that existed
before the financial--before 2008, weeks before they failed.
So, the prudential requirements before 2008 were just
manifestly inadequate and permitted all kinds of abuses and
really had to be reformed.
Mr. Clay. Do you support the Volcker Rule's prohibition on
proprietary trading so that banks that benefit from the
Federal's safety net do not gamble with deposits?
Dr. Stanley. Yes, we do. And a lot of people say that the
Volcker Rule proprietary trading ban is somehow disconnected to
the crisis. But the truth is that banks lost hundreds of
billions of dollars from assets held in their trading books,
firm trading inventories. They lost well over $100 billion in
2008 and that was a major contributor to the financial crisis.
And Volcker, I think, could be improved in a variety of
ways but it takes that on and that is a critical issue.
Mr. Clay. All right, thank you for your responses. And, Mr.
Chairman, my time is up.
Chairman Luetkemeyer. The gentleman's time is up. With
that, we have a second round. Mr. Barr would like to ask a few
additional questions. He is recognized for 5 minutes.
Mr. Barr. Thank you. And I appreciate the second round, Mr.
Chairman. And to Mr. Fromer or Mr. Baer. The question is about
this mono-model of stress testing. And I think, Mr. Baer, you
specifically touched on this. I am interested in this because I
have heard Randy Quarles talk about this as a risk for
regulators to focus on a mono-model testing.
And I am curious to know your thoughts on how the Fed and
other regulators can avoid--best avoid a mono-model stress
testing regime. And how can we avoid a situation where banks
and participants in the financial services sector are moving in
the same direction, creating and concentrating risk, as opposed
to allowing an organic diversification of risk that is--that is
fueled by a diversity of stress testing scenarios?
Mr. Baer. Sure. You may--I think one potential answer is to
provide full transparency around the model which would also
allow for notice and comment, from a whole wide range of folks
all on this panel, about whether that is a good model or not.
It would allow backtesting and real consideration of it. I know
there have been concerns expressed by some that that would let
the banks know the test.
But, I think of an analogy of, if the EPA decided to
regulate pollution controls and said, we are not going to tell
you the regulation. We are just going to run the secret model,
and, at the end of the year, we are going to tell you whether
you passed or not. And if you didn't pass, then you can't
operate next year. No one would think that that is a fair
system. When the government has rules, we, as citizens, have
the right to know the rules.
Now, if the concern is so great, though, that we aren't
allowed to know the test, then I think it is a perfectly good
option to allow bank models to be used as part of the stress
test. Those models are not made up. They are rigorously
backtested.
And the Federal Reserve now reviews and approves every one
of those models. So, if they can't provide transparency, then I
think there is a ready alternative.
Mr. Barr. Right. So, I think it is purposeful from the
standpoint from financial stability. It is also a due process
issue, of course.
Mr. Fromer, let me just shift gears, actually, to another
question. In recent testimony before this committee, Randy
Quarles, Vice Chairman of Supervision, testified that because
of the improvement in the resolvability of firms realized over
the past few years through the living will process, it is
appropriate now to assess--to reassess the G-SIB surcharge
calculation.
The G-SIB surcharge applied to U.S. banks has nearly
doubled that of the international standard, placing our
institutions at a competitive disadvantage in the global
marketplace. But now, we hear about this stress capital buffer
that, effectively, doubles down on what has already been
acknowledged to be a miscalibrated requirement by enshrining
the G-SIB surcharge in this new rule.
I know you share the same concern. Can you elaborate on why
that is a problem from a--from the standpoint of international
competitiveness?
Mr. Fromer. Sure. First of all, the G-SIB surcharge, as I
stated earlier, was put in place to deal with the systemic
risk, potential for a default, the impact of default in the
system. As Governor Quarles and others have indicated, there
are a number of other steps that took place after the
implementation of the G-SIB surcharge of the establishment
which, to some degree, have made the G-SIB surcharge redundant.
And that is why we believe it is necessary--it is crucial, in
fact--to go back and look at it.
The problem with the G-SIB surcharge is with respect to
international competitiveness. It has to do with the fact that,
in the United States, the regulators applied a higher standard,
known as method two. And method two is, essentially, a higher
charge for these U.S. G-SIBs.
In our view, that actually creates a built-in disadvantage
for U.S. institutions vis aAE1 vis their foreign peers. First
of all, if you feel like the--if you believe that the system
has improved through a variety of different improvements,
whether it is TLAC or clearing and margin or living wills, you
should go back and look at the G-SIB surcharge. And then,
specifically you need to look at method two because of the
built-in disadvantages it provides for the U.S. G-SIBs versus
their foreign peers.
And it is amplified, as I think you are getting to, by the
fact that the G-SIB surcharge now has been imported into two
other schemes, one of which is the supplementary leverage ratio
for the largest banks, and the second is the stress capital
buffer proposal.
Mr. Barr. And so, I think we all should be interested in
the competitiveness of U.S. institutions, relative to the--to
our foreign competitors. And, yet, at the same time, to Mr.
Noreika's testimony, we also know that foreign banks are an
indispensable conduit for foreign investment in the United
States, which is a source of a lot of high-paying jobs.
Frankly, higher foreign direct investments is responsible for
higher paying jobs, in many cases, than domestically produced
jobs.
My question to you is, according to a 2016 Federal Reserve
report, a substantial percentage of loans provided in the--in--
my time may have expired already. Well, I didn't get to that
question but we will continue the discussion, Mr. Noreika, at
another time. Thanks.
Mr. Noreika. Happy to.
Chairman Luetkemeyer. The gentleman from Kentucky is full
of questions. So, we can be here until midnight, and he will
still be asking questions. But good questions.
The Ranking Member, Mr. Clay, has some second questions as
well and he is recognized for 5 minutes.
Mr. Clay. Thank you, Mr. Chairman. And, Mr. Noreika, during
your tenure as Acting Comptroller of the Currency, you moved to
weaken the agency's examination policy for the Community
Reinvestment Act (CRA) with respect to discriminatory or other
illegal credit practices. Can you explain to the committee how
this policy helps combat discriminatory lending?
Mr. Noreika. Well, first of all, no, I didn't. Second, what
I did do was we instituted guidance that put the Community
Reinvestment Act back in--
Mr. Clay. Hope that is not an omen--
Mr. Noreika. Hopefully it is not for one or the other of
us, right? Exactly. So, what I did do was reinstituted a policy
so that, basically, community reinvestment is evaluated for
community reinvestment purposes. So, there had been a trend in
the prior Administration toward penalizing banks for things
that had nothing to do with investment in their communities and
the type of lending activities that they used to claim credit
for their CRA exams.
And so, what we did was we went back to basics of the
Community Reinvestment Act. So, at the outset, each bank is
reviewed, under the current rule at least, for its lending
operations, its service activities, and its investment
activities.
And what we did is we said, with respect to the activities
for which a bank claims lending credit, if those activities are
done in a way that harms consumers, then that will be the basis
for a downgrade. There has to be a logical nexus for the
noncompliant consumer-harming activities to affect the CRA
rating. Because, again, CRA, the whole purpose of it is to make
sure banks are lending in their communities.
We don't want to be overly punitive because then a bank
might decide, hey, we have such big problems. We are not going
to do anything. We are going to get our problems settled and
not invest in the communities. I did not want that to happen.
And what I worried about was that the so-called downgrades,
which expanded more broadly than the activities that were used
to claim credit, would actually act as a deterrent to
investment on communities.
Mr. Clay. And thank you for that response but I was--I am
wondering, did you dig into the numbers to see that, OK, in
economically disadvantaged parts of that service area, did they
do 30-year mortgages? Did they expand 30-year mortgages? Did
they do home improvement loans? Did they do small business
loans? And did that data help you determine the grade?
Mr. Noreika. Well, look, I think you can never decide
something going forward. Obviously, afterwards, you have to
look back and see how it did. And I think that is the general
context of this entire hearing is looking back at things that
may have been perfectly reasonably put in place at the time but
may have a deleterious effect or just the market changes over
time.
With respect to Community Reinvestment Act. Look, I think
the original purposes of the Act were, again, clearly to get
banks to not abandon their local communities. A very laudable
effect. I think the worry was that a lot of other baggage was
getting placed on that that, ultimately, would deter lending in
communities.
And that is what, frankly, concerned me the most in why I
instituted that examination guidance was to, again, get back to
the basics and encourage banks to lend in their community and
not deter them from doing that.
Mr. Clay. But think about the challenges that impact
economically disparate communities, economically disadvantaged
communities. Those are the ones that need the financial
stimulus the most.
Mr. Noreika. Oh, I absolutely agree with you.
Mr. Clay. And so, I mean, that is what--
Mr. Noreika. I absolutely--
Mr. Clay. I always thought the CRA was.
Mr. Noreika. No, I absolutely agree with you. And I do
somewhat worry CRA was getting highjacked as just another way
to penalize banks for general things they did wrong to
consumers. And I think there has to be that absolute laser
focus of CRA on the underserved communities, themselves, and
getting banks to invest in them. And that was why I did what I
did.
Mr. Clay. And that is why we have the CFPB as to be the cop
on the beat, I would think. Thank you. I yield back.
Chairman Luetkemeyer. The gentleman's time has expired.
With that, we have the gentleman from Georgia. Mr. Loudermilk
has returned and he is recognized for 5 minutes.
Mr. Loudermilk. Thank you, Mr. Chairman. And I would like
to start off by yielding a portion of my time to my friend from
Kentucky, Mr. Barr, so he can continue that very intriguing and
interesting line of questioning that he was--
Mr. Noreika. You are not going to get me out of the
question here are you?
Mr. Barr. I want to thank my friend. And I will be brief
since I have already consumed too much time.
But to follow up to Mr. Noreika. Just as the G-SIB
surcharge could put U.S. banks at a competitive disadvantage,
what I was getting at in my question was that, similarly,
unfair treatment of U.S. subsidiaries of foreign banks could
also be a problem, from the standpoint of U.S. economic growth.
Because it could in--could incentivize those foreign banks to
decrease their U.S. operations and could lead to a withdraw of
foreign funds. Many of which are contributing to foreign direct
investments which, again, is a source of a lot of jobs and
economic growth.
So, the question is, from a competitive equity standpoint,
how can we approach regulations to make sure that U.S.
subsidiaries of foreign banks operate on a level playing field
with our counterparts?
Mr. Noreika. Sure. And that is the statutory directive. But
I must say, from my time in office, having seen these foreign
banking organizations come talk to me, they were dramatically
pulling outside--out of the United States, especially with
respect to the capital markets' type activities. That before
the intermediate holding company requirement had been the
subject of functional regulation under the Gramm-Leach-Bliley
Act. Due to the international--intermediate holding company act
had been pulled into banking regulation and subject to these
enhanced prudential standards. The cost of doing business
apparently went through the roof and drove that capital outside
the United States.
And I think, to the detriment of our country, as you are
pointing out, in the sense of the markets are less liquid, the
activity is pushed out into less-regulated spheres. And,
obviously, there is the real-world impact on people who may be
employed or not employed anymore by these institutions.
Mr. Barr. And I better reclaim Mr. Loudermilk's time. Thank
you, my friend.
Mr. Loudermilk. All right, thank you. And, Mr. Noreika, we
will continue with you since we have you there. My question
really is around the SIFI (systemically important financial
institution) designation. And under Dodd-Frank, it specified
between $100 and $250 billion in assets. Those financial
institutions are entitled to complete relief from regulation as
a SIFI institution after an 18-month transition period.
My understanding is, also, that after that period, that the
law gives the Fed the ability to restore the regulations if the
bank becomes a systematic risk. But under the current
conditions, the recent CCAR results and G-SIB surcharge risk
data shows that banks with less than 250 billion in assets do
not present this type of risk. I, as well as others, think they
should be exempt from all the regulations associated with being
SIFI unless there is significant change to risk profile.
My question is, do you agree that these banks do not
currently pose that type of systemic risk?
Mr. Noreika. I do, Congressman. Certainly, if those are the
Fed's own findings, with respect to systemic risk, I don't
think there is any reason to wait to exempt them from the
enhanced prudential standards while the Fed then goes and
reviews how the standards need to be revised in light of the
new law.
Mr. Loudermilk. OK, thank you. Mr. Baer, with the short
time that I have remaining. I understand that some of the
biggest challenges of the CCAR stress test, in addition to the
sheer burden of these Dodd-Frank requirements, is the fact that
the stress test models used by the Fed are relatively secret.
In a 2016 GAO report, it showed that CCAR process is overly
qualitative, offered too little communication for regulated
banks, and that the scenarios were designed without appropriate
analysis. Can you shed light on why that is such a problem for
institutions such as yours?
Mr. Baer. Sure. It is difficult even to explain how
complicated the CCAR process has become. What a data drain it
is. What a resource drain. I think even for banks in the 100 to
250 billion who we expect to no longer be doing this, there are
probably dozens of people, maybe up to 100 at the bank doing
this full time. At the larger institutions, it is hundreds of
people doing this full time. It is a very intensive data
exercise.
And then, of course, as I got to earlier, they really don't
know a lot about the model that they are trying to manage to
them. You can try to reverse engineer some things and we have
actually tried to derive the implicit risk weights from what
that model produces. And you can get some indications.
But it is a very difficult process. Again, I do support
stress testing for large complex institutions that have really
complex risks. But, particularly for a $100 to $250 billion
institution, we have traditional supervision. Without that, it
is unnecessary, I believe.
Mr. Loudermilk. Thank you. With that, I yield back.
Chairman Luetkemeyer. If you have some additional
questions, gentlemen, you can be certainly recognized because
we have a little time here.
Mr. Loudermilk. In other words, I am the only one left, Mr.
Chairman, is that right?
Chairman Luetkemeyer. It is raining outside and the game
hasn't started yet tonight so we are OK with it.
Mr. Loudermilk. Well, I think with the last thunder clap,
everybody ran. I don't--I hope they are not going two by two to
a big wooden boat somewhere. Maybe we should--
Well, then, I do have--I will also defer to Mr. Fromer to
answer the same question if you would like.
Mr. Fromer. I think what I will add to what Mr. Baer said
was that for banks of all sizes, it is a difficult process. It
is a complex process. It is resource consumptive. But the other
thing is that it makes it extraordinarily difficult for the
boards and the management of these institutions to go through
this thoughtful process of planning the deployment and the
distribution of their capital.
And to the extent that you have opacity in the models, and
to the extent that you get scenarios presented to you in
February for a process that is supposed to conclude and does
conclude in June, and then you live with the results for the
next quarters and have no flexibility in terms of your further
distribution of capital. Even though there may be things going
on in your firm or things going on in the economy at large
which affect the operation of your firm, affect the plans that
you have made and your ability to dynamically change the nature
of your business with those events.
The process right now is very constraining. And, in effect,
it says, even though you have met your minimum requirements,
even though your institution is safe and sound, you have all
your minimum requirements in place, you as a board, you as a
management are still restricted, in terms of the way you can
deploy and distribute your capital.
And that is sort of an erosion of fiduciary responsibility
that we think needs to be addressed as part of the overall
review.
Mr. Loudermilk. So, does this inhibit your ability to
properly serve your customers?
Mr. Fromer. Inevitably, it does. If you have gone through a
thoughtful planning process, as our institutions all do, and
you are constrained by information that you do not have,
because you just don't have access to it. None of us can sit
here and tell you what goes on, with respect to these models
and how the scenarios are actually put together. Because it is
opaque.
So, the degree that you can't make decisions about the
operation of your institutions, it inevitably affects the kinds
of services that you are going to provide to your customers and
the pricing as well.
Mr. Loudermilk. And Mr. Baer?
Mr. Baer. If I could just say, there is also a really
important credit allocation component to this. We did--our
research team went back and looked and derived the implicit
risk weights for CCAR compared to the standardized approach and
then compared to the bank's own modeled approach through DFAS.
And what they showed was that the implicit risk weights, that
is the capital charge, were dramatically higher for certain
asset classes. Most notably, small business, prime mortgage,
and market making.
It is actually about the same for C&I. But, so, implicitly
in this, though, is that it is driving banks in certain
directions and driving all the banks in the same directions.
And it is interesting, we, then, took the next step and said,
well, can we see that in the actual data in how banks behave?
And what you know, if you look, and I think some of this is
in my testimony, which I know some of this is in my testimony,
if you compare banks subject to CCAR banks versus banks not
subject to CCAR, and look at their behavior, you will see the
banks that are subject to the test are moving out of the asset
classes that are most affected by the test.
Mr. Loudermilk. OK, thank you. Mr. Chairman, I don't have
any further questions. I could--be glad to yield to you or I
yield back.
Chairman Luetkemeyer. We are already on our second round,
so you get your second round of questions. So, if you are done,
well, we will move on.
Mr. Loudermilk. I am done.
Chairman Luetkemeyer. The gentleman yields back. OK. I have
just one comment which is, the reason for the stress test,
originally because of Dodd-Frank, was because of the
systemically important institutions that could bring down the
economy.
And I think we have talked about in the bill that--2155
that set thresholds. And while I am not a big fan of
thresholds, I think anybody would recognize that $250 billion
bank, while that is a big bank, it is not big enough to bring
down the economy of the United States.
And so, I think you have to remember why that part of Dodd-
Frank is there and why--what kind of implications it could have
and should have. And most banks now that are exempt under 250,
I--we have--I guess we will watch the actions of the Fed. But I
know the regulators. But we--they should not be considered
systemically important the part where they are going to be
negatively impacted by overburdenedsome regulations of
additional tests.
One thing we haven't talked about yet, we have discussed
pretty thoroughly everything else, is--and, Mr. Baer, I think
you brought this up, is CECL. Can you comment, and Mr. Fromer
perhaps as well, with regards to the impact of CECL loan
capital accounts and if you have seen any kind of impact at
this point yet.
Mr. Baer. Certainly. Thank you, Congressman. I think it is
a terrifically important issue, and I appreciate the
opportunity. I think CECL began with a very good idea. The
Financial Stability Board recommended to the Fed that they look
at the accounting for reserves. The concern was that reserving
can be quite cyclical. That is in the midst of a crisis, banks
are having to add reserves. And that means they are shrinking
lending.
A fundamental mistake, though, I think was made in
projecting what the effect of this would be. The change was
made from the incurred loss methodology which basically said,
you set up your reserve when loss is estimable and probable.
That has been the standard for 40 years. The new requirement
says that you have to set up a reserve at the time you make the
loan for all projected losses over the life of the loan, even
if the chances of those are small.
Meanwhile, you cannot book any potential income from that
loan over the course of the loan--of its life. So, that is a
fairly significant change. But the idea was, OK, well, let us
have them take the reserve at the beginning. And then, when
things go bad, they won't have to restrict and build a big
reserve.
The fundamental problem with that, though, is it presumed
and, I think, the analysis done by economists on it, presumed,
as economists like to presume, perfect knowledge. So, they
presumed that everybody got it right at the start.
What our team did, after hearing a lot of nervousness from
the CFOs about this, is we actually went back and we ran the
2007 to 2009 financial crisis. And we said, let us not presume
perfect knowledge. Let us actually look at what the
macroforecasts actually were at the time. Stand in the economic
community and see what happened.
And what happened was they didn't have the perfect
knowledge. And what happened is you got into 2008. That is when
all the forecasts went bad or assumed that there was going to
be a very large recession.
And so, what would have happened if CECL had been in place
is there would have been massive reserves taken. Not just
reserves on the loans for which losses were already estimable
and probable. But loans for every need, a reserve for all
loans. And particularly for loans for low- to moderate-income
people.
So, what our review shows is if CECL had been in place, it
would not have been countercyclical, it was not of built
reserves in 2006 and 2007. It would have been profoundly
procyclical and would have met massive bank reserves in 2008,
which almost certainly would have dramatically heightened the
recession. So ours shouldn't be the last word on this.
And we are trying to encourage more research, not
discourage more research. But it is certainly the gut sense of
the folks in finance that we have talked to at the bank so we
think it is a terrifically important issue.
Chairman Luetkemeyer. Anybody else want to comment on that?
No, OK. Basically, we are finished here. Would anybody like to
have a closing comment? I can go down the line here and I can
give everybody about a minute, minute and a half to just make a
couple closing comments on issues that came up that you would
like to talk about that maybe weren't thoroughly discussed or
reiterate one specific point. Mr. Fromer.
Mr. Fromer. Thank you, Mr. Chairman. I think the point that
I would make is that simply a reiteration of the view that
there is an opportunity now and a lot of experience that, I
think, regulators here and abroad can use now to do a complete
review, specifically around these individual actions and the
interaction among them because there is an interdependency. And
in doing so, I would also add that we obviously went through a
tumultuous time 10 years ago and we have done an enormous
amount of work to address the results of the crisis.
And these are extremely highly capitalized institutions, as
we have talked about. I think no one really wants to go back
and turn the clock on that. We are not looking at going back to
the future, if you will. But we do think it is important to
take stock of what we have done and make sure that we are doing
it in the most cost-effective way possible.
Chairman Luetkemeyer. Thank you. Mr. Baer.
Mr. Baer. Just a couple thoughts. First, I do think it is
important to acknowledge how tough capital regulation is. If
the regulators come up with something very granular, we
criticize them for credit allocation. If they give up and go to
a leverage ratio and say every asset has the same risk, we
criticize them for not thinking things through. So, it--I am
sure there is some medium in there but it is not so easy and
happy to find. And so, they deserve our empathy and they also
deserve our notes and comment on that.
I think we touched on it a little bit today but I do think
the unseen world of bank examination is as important as the
overt world of bank regulation. And that there are a lot of
requirements going on out there that we don't even know about,
and that it is very important for this committee and others to
focus on.
I would also just say, although I share the enthusiasm
about equity, I did want to put in a word for debt,
particularly for larger institutions that issue debt to the
markets. That now, post-crisis, the way resolutions are
conducted is actually quite loss absorbent and protects
taxpayers.
And there is about a trillion dollars of it out there, at
least for our members. It also brings into play a group of
investors and analysts who are quite worried about losing their
money and also exert a significant amount of market discipline.
So, I think that is a benefit.
And I would also add that post-crisis, I think there have
been--at least a GAO study and a couple of other academic
papers looking at post-crisis debt pricing spreads. And there
is no evidence that large banks are receiving a premium in the
market or a discount, however you want to look at it. But they
are being able to issue cheaper, as a result of some too-big-
to-fail premium.
So, that is really market debt. Of course, the easiest way
to figure out its market debt is to turn on a Bloomberg machine
and see that it is priced the same way market debt is for other
large institutions in other industries.
Chairman Luetkemeyer. OK. All right, thank you. Dr. Holtz-
Eakin.
Dr. Holtz-Eakin. Well, I applaud the committee for holding
this hearing. And I think it is a good time to do a holistic
review of the regulatory apparatus. And I would encourage the
committee, the regulators, to look at these institutions
holistically. I think the thing I find most troubling in many
discussions is the notion that we can separate systemic risk
over here and get a capital charge for that. Sort of a
prudential regulation over here and an enhanced prudential
regulation up here. Liquidity regulation over here. That is not
the way the world works.
And one of the reasons I think a more robust stress testing
regime is desirable is it takes a holistic look at the
performance of the institution through the stress. And I think
that should be the focus.
Chairman Luetkemeyer. Very good. Dr. Stanley.
Dr. Stanley. Yes, a couple thoughts. One is I think there
tends to be this trend or pattern that whenever we see a change
in behavior, by banks in response to new capital requirements,
that this is somehow a cost or a bad thing. And I don't think
that is true.
Mr. Noreika talked about how U.S. subsidiaries of foreign
banks have decreased some of their capital markets' activities
in the U.S. because of the intermediate holding company rule.
Well, I don't think that Credit Suisse or Deutsche Bank, CBO
desks activities before the crisis were doing any favors for
the U.S. economy, nor were there enormous credit lines where
they pulled all--borrowed all these dollars in the U.S. and
then couldn't pay them back without Federal Reserve assistance.
That--those capital markets' activities were not doing anybody
any good. And the idea that they might have become more
responsible about those activities I think might be a positive
impact of the IHC rules.
And also, just in terms of this competitiveness, the
argument about competitiveness with Europe. And I think it is
pretty clear that the U.S. banking sector is in a lot better
shape than the European banking sector. There are still major
concerns about the weakness of that sector. And, to some
degree, I think the higher prudential requirements in the U.S.
have been a competitive advantage of our banks because people
know that our banks are safer and sounder and better to deal
with.
Chairman Luetkemeyer. Mr. Noreika.
Mr. Noreika. Well, thank you, Mr. Chairman, and thank you
for having me here today. I just want to conclude by saying,
look, I am very optimistic about the banking sector, about the
regulation of the banking sector.
I think with the passage of the new law and the new
regulated--regulatory heads finally in place, we have a real
opportunity to take stock, to look at all the regulations that
have been put in place and how they have been enforced over the
past 10 years. I think when we talk and we hear the--
particularly the Vice Chairman for Supervision at the Fed, talk
about tailoring and transparency. Those are welcome thoughts in
the bank regulatory sphere.
And I think now the devil is in the details. And, to me,
the details are a soup-to-nuts review of how all of the
cumulative effects of these regulations have impacted the
various segments of the financial system. In particular, I
think are the subsets that I talked about today. Those in the
$100 to $250 billion range, which is going to merit a review by
the Federal Reserve and those in the foreign banking realm.
But, again, I think we have the approach here now to take a
look and to tailor and to make more rational our regulation of
these banks. And I think, hopefully in a few years, we will
reap the results from that.
Thank you.
Chairman Luetkemeyer. Thank you. And thank all of the
witnesses today for the testimonies. It has been great. You
guys are fantastic.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
With that, this hearing adjourned.
[Whereupon, at 3:50 p.m., the subcommittee was adjourned.]
A P P E N D I X
July 17, 2018
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