Brookings Event with Fed’s Quarles

Brookings Institution

“The Future of Financial Regulation”

Friday, November 9, 2018

Keynote Presentation

Randal Quarles, Vice Chairman for Supervision, Federal Reserve Board

In his opening remarks, Quarles laid out his topics of discussion, including proposed changes to be made for the stress testing regime, what has been successful about the regime and should remain, how to move forward with the proposed changes, and the qualitative element of stress tests. He noted that the adjustments to stress tests are intended to increase transparency and efficiency within the regime, and that the combination of Fed-conducted stress tests and firm stress tests has resulted in a “meaningful” increase in resiliency within financial institutions, stressing that this combination will remain in place. Quarles continued that the changes are not meant to significantly alter the level of capital in the financial system, noting that banks subject to the Comprehensive Capital Analysis and Review (CCAR) have increased the dollar amount in the Tier 1 capital from $500 billion in 2009 to over $1.2 trillion in Q2 of this year.

Quarles then discussed the stress capital buffer (SCB) proposal to integrate stress tests with the regulatory capital rule, stating that the SCB will result in “a more transparent, simple system,” as firms will be held to a single, integrated capital regime. He continued that the SCB proposal was supposed to be final for the 2019 stress test cycle but that the Fed has received extensive comments that have raised issues warranting a “careful response.” Quarles stated his expectation that a final rule will be adopted in the “near future,” adding that the SCB will not go into effect until 2020 at the earliest, and that CCAR will remain in place for 2019 for those institutions with over $250 billion in total assets or that are otherwise complex. Quarles explained some of the concerns the Fed has received regarding the volatility of stress test results and how capital requirements can change significantly year-to-year, stressing the need to preserve dynamism. Quarles continued that another adjustment to the SCB proposal could be the way they are conducted, as currently a firm must provide a formal plan without knowing their effective capital requirement. He also added that comments have highlighted the issue of how the capital buffer is operated. Quarles explained that the SCB includes a post-stress leverage requirement, but that there is concern regarding explicitly assigning a post-stress, risk-sensitive leverage requirement, adding that this element of the capital regime may warrant being removed.

Regarding the transparency of stress test results, Quarles explained that the Fed will issue a policy statement describing governing principles around supervisory stress tests, possibly with additional detail on models and results, aimed at early 2019 so changes can allow firms to benchmark their results against the supervisory models. He continued that additional options to provide greater transparency include the Fed seeking comment from the public on scenarios and risks facing the industry. Quarles then discussed normalizing the CCAR qualitative assessment by removing the public objection tool, noting that the Fed eliminated the stress test qualitative objection for large but not complex firms in 2017.

Fireside Chat and Q&A

Regulatory Reform

Martin Baily, Senior Fellow at Brookings, noted that the Fed has received criticism that they have gone too far with regulatory reform and also that they have not simplified regulations enough. Quarles replied that the Fed has released multiple proposals and that the SCB would reduce the number of capital measures banks face from 24 down to 12, but that the Fed should continue thinking of ways to improve the efficiency of the regime. Baily then noted that capital and total loss absorbing capital (TLAC) requirements remain the same for global systemically important banks (GSIBs), to which Quarles replied that the Fed continues to look at the framework impacting the largest banks, but that the objective is not to change their capital requirements. He continued that the Fed has focused on implementing S.2155 which focused on smaller institutions, not GSIBs.

Regarding the countercyclical capital buffer, Quarles explained that it is an international financial stability tool, “not a macroeconomic dampener,” and that it is designed to be in the framework and turned on when financial stability risks are above normal. He noted that there are international regimes that think the countercyclical capital buffer could be more efficient, but that work has not been done on this front.

Volcker Rule

Baily then asked about simplifying the Volcker Rule, to which Quarles replied that the rule has impacted the liquidity in some markets, though it is difficult to quantify. He continued that there is “universal agreement” that the rule is too complicated from a supervisory and enforcement perspective, and that it is “totally sensible” to have a simpler approach in implementation. Quarles added that the five agencies are working together to process the comments received from the proposal.

FSOC Designation

Baily noted that the Financial Stability Oversight Council (FSOC) decided non-banks should not be included in Fed supervision and asked if Quarles is comfortable with this. Quarles disagreed with the characterization and replied that they are always monitoring how leveraged institutions are, and that rather than regulating all non-banks, FSOC is focusing on activities-based rather than entity-based analysis.

Resolution

Regarding the resolution process, Baily asked if multiple institutions failing at the same time would lead the economy into another 2008 crisis. Quarles replied that policymakers have more options available to them for the next wide-spread stress event that will significantly reduce the likelihood of having to resolve multiple institutions at the same time.

Stress Test Transparency

Baily asked how Quarles can increase the transparency of stress tests while not “giving away the exam” to financial institutions. Quarles replied that there is a difference between giving banks test questions and providing them with a “textbook,” adding that banks already reverse engineer with each stress test.

Current Expected Credit Losses (CECL)

An audience member asked about whether a cost-benefit analysis would be conducted for CECL and whether there would be harmonization among regulators regarding capital rules. Quarles replied that the use of CECL in regulatory capital regulations will be phased in and that there will be time to evaluate its impact.

Incentive Compensation

Quarles noted that the Fed has received “a lot” of technical issues within comments received on the incentive compensation proposals and that they are looking at a firm’s compensation practices when doing regular exams, adding that the issue is still being thought about.

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