Large Banking Organizations and Banking Organizations with Significant Trading Activity (Joint Trades)

Summary

SIFMA, The Bank Policy Institute (BPI), the Financial Services Forum (FSF), and the U.S. Chamber of Commerce provided comments to the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (collectively, the “Agencies”) in regard to the Agencies’ proposed rulemaking that would amend the capital requirements applicable to large banking organizations and those with significant trading activity.

Excerpt

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue, NW

Washington, D.C. 20551

Attention: Ann E. Misback, Secretary

Federal Deposit Insurance Corporation

550 17th Street, NW

Washington, D.C. 20429

Attention: James P. Sheesley, Assistant Executive Secretary, Comments/Legal OES

Office of the Comptroller of the Currency

400 7th Street, SW, Suite 3E-218

Washington, D.C. 20219

Attention: Chief Counsel’s Office, Comment Processing

Re: Regulatory Capital Rule: Large Banking Organizations and Banking Organizations with Significant Trading Activity (Federal Reserve Docket No. R-1813, RIN 7100-AG64; FDIC RIN 3064-AF29; Docket ID OCC-2023-0008)

Ladies and Gentlemen:

The Bank Policy Institute, the Financial Services Forum, the Securities Industry and Financial Markets Association and the U.S. Chamber of Commerce1 are filing this comment on the joint notice of proposed rulemaking issued by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency that would amend the capital requirements applicable to large banking organizations and those with significant trading activity.2

As described below, any final rule adopted based on this proposal would violate the Administrative Procedure Act, 3 and the proposal’s defects can only be cured through proposal of a new rule.

Risk-based capital requirements are based on ratios that take a bank’s regulatory capital4 as their numerator and risk-weighted assets as their denominator; the proposal largely focuses on the latter and would fundamentally change how risk-weighted assets are calculated for nearly every type of asset and exposure. The risk weight attached to each asset has a direct and significant effect on whether a bank chooses to hold and how it prices that asset; collectively, those risk weights drive the bank’s overall capital requirement and its ability to compete for capital against other companies. Simply put, the stakes of how bank assets are risk-weighted are extremely high for banks, consumers, businesses and other bank customers, and the U.S. economy.

The proposal would result in a complete overhaul of how assets are risk weighted. First, the proposal would require all banking organizations with total consolidated assets of $100 billion or more to meet all applicable risk-based capital requirements as calculated under both (i) the existing U.S. standardized approach, as modified by the proposal and (ii) an entirely new “expanded risk-based approach” (“ERBA”) that includes entirely new standardized measures for credit risk, operational risk, and credit valuation adjustment risk (“CVA”).5 Second, the proposal would eliminate entirely the existing U.S. internal models-based approach to calculating risk-weighted assets for credit risk. Third, the proposal would introduce a new approach to market risk into both the U.S. standardized approach and ERBA. Through these revisions, the proposal would substantially increase the regulatory costs of about $22 trillion in assets held by banks subject to the proposal, which represent 80 percent of all U.S. banking assets.

Given the consequences of the proposal’s sweeping changes, one would reasonably expect the agencies to have undertaken a policymaking process that was deliberate, transparent, and based on all available data, and to have carefully considered all relevant aspects of the problems the proposal purports to address and potential alternative approaches to those problems. Unfortunately, the agencies failed to do so. The agencies provide no empirical justification or support for the weight assigned to numerous assets, even where they possess voluminous historical data that enables the evaluation of the risk of those assets. In the few cases where the agencies do state that they are relying on actual data, they have chosen not to disclose that data secret or to assert reliance on their collective “supervisory experience.” And, not surprisingly given its deficit of data and analysis, the proposal makes no serious attempt at weighing its costs and benefits. Instead, the agencies simply purport to implement agreements reached in 2017 and 2019 by the Basel Committee on Banking Supervision, though even then with some significant deviations, almost always in a more stringent direction.6 The ultimate result is a proposed rule that, if finalized, would be arbitrary, capricious, and an abuse of agency discretion. As such, the agencies should repropose the rules before finalizing them.

In a separate, forthcoming companion comment letter, we analyze the proposal in detail, and identify as a matter of substantive capital policy what revisions to capital requirements based on sound data and sensible analysis would look like. That letter effectively treats the proposal as an advance notice of proposed rulemaking, and we hope that it will assist the agencies in producing a new proposed rule that employs data and analysis to calculate risk, appropriately analyzes the costs and benefits of potential changes to their capital rules, and provides the public with adequate information on which to comment. As both a procedural and substantive matter, the current proposal fails that test.

In this letter, we focus on the proposal’s legal deficiencies, and organize our discussion as follows: Part I provides an executive summary of the proposal’s legal problems; Part II describes applicable legal requirements under the APA; Part III describes how the proposal violates both the procedural and substantive standards of the APA because it lacks a sufficient evidentiary basis, ignores evidence that is available, fails to explain the methodology and assumptions that underlie the proposal, and improperly fails to disclose underlying data and analysis from the public; Part IV describes how the proposed rule’s reliance on Basel Committee agreements as a floor for any U.S. requirement is improper and arbitrary; Parts V through VIII identify the numerous reasons why the proposal is arbitrary and capricious and thus violates the APA’s requirement of reasoned decision-making; Part IX explains why, as applied by the agencies in the proposal, the bank capital statutes would violate the non-delegation doctrine; and Part X describes why the agencies should issue a new proposal to amend the capital rules in a manner consistent with APA standards should they choose to move forward with any changes to those rules.

Executive Summary

• The APA establishes clear procedural and other requirements that apply to all federal agency

  rulemaking, including the proposal.

• The proposal violates both the procedural and substantive standards of the APA because it lacks a sufficient evidentiary basis, ignores the evidence that is available, fails to explain the methodology and assumptions that underlie the proposal, and improperly fails to disclose underlying data and analysis from the public.
  • The proposal’s framework of proposed risk weights is not supported by sufficient data, evidence, or analysis; nor is it based on any standard of risk against which data, evidence,

    or analysis could be judged.

  • The proposal’s approach to operational risk is based on unsubstantiated assertions about

    the general nature of operational risk, the relationship between operational risk and

    business activity, and the relative operational risk of fee-based activities.

  • The proposal would eliminate any role for internal models in calculating credit risk capital

    on the basis of conclusory, unsupported assertions that are belied by a massive body of

    evidence and conflict with current agency practice and past agency statements.

  • The proposal’s punitive treatment of loans and other exposures to small- and mediumsized businesses that do not issue public securities is based on no data or analysis at all.
  • Key parts of the proposal’s approach to market risk and CVA risk are proposed with no

    justification or explanation at all.

  • Other key elements of the proposed rule rely on a wide variety of data, analyses, and methodologies that appear to exist, but have not been made available to the public for -4- January 12, 2024 review and comment.
  • The proposed rule repeatedly relies on non-public analyses that are said to arise from the

    agencies’ “supervisory experience” and related conclusory assertions.

  • Any data collected and analyzed by the Federal Reserve cannot support any final rule

    unless the agencies make that data and analysis available for public comment.

• The proposed rule’s treatment of Basel Committee agreements is improper.
  • The proposed rule unjustifiably incorporates most aspects of the Basel Committee’s 2017 and 2019 revisions without any independent analysis, explanation, or support offered by the agencies themselves, and without revealing the data (if any) relied upon in reaching those agreeements.
  • The proposed rule also departs from the requirements of the Basel agreements in

    unexplained and inconsistent ways.

• The proposed rule fails to consider many other important aspects of the problem.
  • The proposed rule does not account for the fact that the new capital requirements would largely duplicate the capitalization of risks that are already captured by the Federal Reserve’s stress-test framework.
  • The proposal fails to consider the lack of correlation or negative correlation among the

    credit, market, operational, and others risks for which it would impose capital charges on a summary basis.

  • The proposal fails to meaningfully consider the concrete competitive and market

    consequences of subjecting different banks to different capital requirements for identical loans, assets and activities.

  • The proposal fails to meaningfully consider the practical and policy problems associated with subjecting larger banks to two differently calculated capital requirements for identical loans, assets, and activities.
  • The proposal fails to meaningfully consider the demonstrable financial stability risks and social costs of creating significant regulatory incentives for the shift of lending, capital markets, and other activities to less-regulated financial institutions.
  • The proposal fails to meaningfully consider potential tensions and inconsistences between what the proposal would require and other existing legal requirements for banks.
• The proposed rule is based on economic analysis that is deficient and inconsistent with the

  evidence.

• The proposed rule would significantly increase capital requirements for large banks without

  evidence that current requirements are insufficient, and in the face of considerable evidence

  (incuding statements by agency principals) that current requirements are more than adequate.

• The proposed rule does not consider numerous viable alternatives.
• As applied by the agencies in the proposal, the bank capital statutes would violate the nondelegation doctrine.
• The agencies should propose a new rule that corrects the proposal’s numerous legal deficiencies.

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1 See Appendix for more information on the Associations.

2 See Regulatory Capital Rule: Large Banking Organizations and Banking Organizations With Significant Trading Activity, 88 Fed. Reg. 64028 (Sept. 18, 2023) [hereinafter the “Proposal”].

3 5 U.S.C. § 551 et seq.

4 Regulatory capital primarily consists of shareholder equity in the bank.

5 A “standardized” approach to calculating RWAs involves the creation of separate categories of exposures, with all exposures within a category receiving uniform risk weights across all banking organizations. This stands in contrast to internal models-based approaches to calculating RWAs, in which banks use models based on their own loss history, calibrated to a certain standard mandated by the regulator, to assign bespoke risk weights to their exposures.

6 In 2017, the Basel Committee on Banking Supervision (the “Basel Committee”) adopted significant changes to the standard for calculating RWAs associated with credit risk and operational risk. With respect to credit risk, the revised standard permits firms to continue to use internal models to calculate RWAs, but placed a floor on the output of those internal models based on standardized measures of RWAs. With respect to operational risk, the revised standard eliminated internal models in their entirety and introduced a standardized approach to calculating RWAs. As explained below, policymakers intended that these changes would not result in meaningful increases to overall capital requirements. To address perceived shortcomings with the previous international standard (primarily, under accounting for tail risk), the Basel Committee also adopted a new standard for calculating RWAs for market risk in 2016, which was then revised in 2019 to address certain calibration concerns.