HFSC Hearing: Oversight of Prudential Regulators

House Committee on Financial Services

Oversight of Prudential Regulators

Wednesday, November 15, 2023

 

Topline

• Republicans expressed concerns about the Basel III endgame proposal, especially regarding the cost of credit and impacts on the trading desk.
• Members from both parties questioned the impact of the Basel III endgame proposal on community banks and small businesses.

Witnesses

• Michael Barr, Vice Chairman for Supervision, Board of Governors of the Federal Reserve System
• Martin Gruenberg, Chairman, Federal Deposit Insurance Corporation
• Michael Hsu, Acting Comptroller, Office of the Comptroller of the Currency
• Todd Harper, Chairman, National Credit Union Administration

Opening Statements

Chair Patrick McHenry (R-N.C.)

In his opening statement, McHenry discussed how the prudential regulators are attempting to use recent banking crises to justify the slate of rule proposals put forward. He went on to say that many recent proposals, including the Basel III endgame proposal, have nothing to do with the bank failures in March and that banks are instead attempting to place bureaucrats in charge of bank’s balance sheets, credit flows, and evaluations of what is and isn’t risky. McHenry then highlighted the Basel III endgame proposals which he criticized for having no credible motivation, a lack of economic analysis, and for stifling economic growth and limiting lending. He accused the regulators of ceding control to global governance bodies, which do not represent American interests. Specifically, McHenry noted the Federal principles for climate related risk management which he said were made in the image of the interests of global regulator’s views. McHenry then said that he would request the GAO to examine whether these principles would qualify as a rule and be subject to the Administrative Procedure Act (APA). He then mentioned the GAO’s recent decision that the SEC’s Staff Accounting Bulletin (SAB) 121 fit the APA’s definition of a rule and would make it subject to the Congressional Review Act (CRA). McHenry continued, saying that regulators need to focus on the interests of the American people and businesses rather than focusing on partisanship and short-term political gains. He closed by saying that recent proposals call into question the independence of regulators and their focus on policy objectives rather than being based on sound economic analysis.

 

Ranking Member Maxine Waters (D-Calif.)

In her opening statement, Waters began by applauding the work of regulators and the Biden administration in the wake of recent bank failures to protect the economy. She then said that regulations put forward by the regulators are intended to address weaknesses in our financial system and that Democrats in Congress are doing their part to address these weaknesses through a wave of bills including one to hold bank executives accountable. She encourages her colleagues to pass these bills which are moving with bipartisan support in the Senate. Waters also applauded the regulators’ work on the Community Reinvestment Act which had not been updated in the nearly three decades prior. She concluded by expressing worry about the recent reports regarding the FDIC being a toxic workplace especially for women.

 

Representative Bill Foster (D-Ill.)

In his opening statement, Foster opened by saying that while the banking system is resilient, recent bank failures proved that the risks taken on by some banks, if not properly managed, can result in contagion across financial institutions. Foster noted that while the issues from recent bank failures has calmed, developing risks, like climate change, cyber risk, and geopolitical risk, and traditional risks, like interest rate risk, still threaten the banking sector. He said that recent proposals from prudential regulators are meant to account for lessons learned from the Global Financial Crisis and recent bank failures and that these proposals will influence the banking sector and overall economy.

 

Testimony

Michael Barr, Vice Chairman for Supervision, Board of Governors of the Federal Reserve System

In his testimony, Barr explained that while the banking sector has recovered from recent shocks, some banks have seen a decline in the fair value of certain assets as interest rates decreased, putting pressure on tangible capital. Barr said that these banks are actively managing these risks, but that it may take some time to address them. He then explained that some banks that have a high reliance on uninsured deposits are using more expensive funding sources to manage their liquidity. Barr highlighted the importance of continued adaptation to protect the financial system. He said that the Fed is working to improve the speed, force, and agility of its supervision, with supervisors focused on the material risks of the current economic environment. Barr invoked the pain felt by Americans during and after the 2008 financial crisis and explained that the reforms made following that period improved the stability and viability of US banks. He then said that the current Basel III endgame proposal is the final piece of these reforms. He underscored that the proposed capital requirements would apply to fewer than 40 banks in the US and would be based on a bank’s risk profile. Barr added that long-term debt and planning requirements will also be strengthened for the most complex banks under the proposed regulations.

 

Martin Gruenberg, Chairman, Federal Deposit Insurance Corporation

In his testimony, Gruenberg noted that the second quarter for banking proved that our financial sector remains well capitalized, while also acknowledging that higher interest rates are causing the values of debt and securities to fall. He said insured deposits increased by 0.8% this year as uninsured deposits fell and explained that commercial real estate loans will continue to slow into 2024 as property values continue to soften. Gruenberg noted the FDIC will require banks to enact a layer of loss-absorbing measures to prevent future failures, and said the FDIC is continuing to address capital weaknesses to prevent future bank failures. He added that the FDIC will conduct a comprehensive review of uninsured deposits and the credit market. Gruenberg concluded by expressing his disturbance over the reports of sexual harassment in the FDIC and said he will take all appropriate actions to address these issues.

 

Michael Hsu, Acting Comptroller, Office of the Comptroller of the Currency

In his testimony, Hsu noted that OCC-supervised banks continue to be well-capitalized and have appropriate liquidity buffers. He said the OCC has published guidance that instructs banks on how to work with credit worthy borrowers in times of financial distress. Hsu said the OCC’s CRA rule will provide updated guidance on providing credit to low and moderate-income communities. He also discussed the OCC’s jointly issued guidance on third-party risk management to remind banks to comply with existing financial regulations regardless of whether their risks are managed internally or externally. He concluded by announcing that the OCC will host its first forum on tokenization for digital assets.

Todd Harper, Chairman, National Credit Union Administration

In his testimony, Harper highlighted the fact that the credit union system still has $2.2 trillion in assets despite the financial turmoil of 2023. He noted that timed deposits have increased 70% during the last year, while credit card balances are much higher than a normal second quarter, indicating that many Americans are dealing with financial stress. Harper concluded by requesting that Congress restore the CLF’s Corporate Credit provisions to address growing liquidity and credit risks.

 

Question & Answer

Basel III Endgame Proposal

McHenry asked what economic analysis was done to support the proposed capital requirements. Barr said the preamble to the rule and the rule itself elaborates on the analysis that went into each provision of the rule with respect to risk calculation. He also noted that the rule is designed to improve the calibration of risks and that within the proposal’s cost benefit analysis, the Fed found the benefits of reducing risks outweigh the costs of the proposal.

 

Rep. Nydia Velazquez (D-N.Y.) asked what economic analysis has been done on the effects of the Basel III endgame proposal on small businesses. Barr said the proposed rule would not impact the cost of credit for small businesses and give some small businesses a lower risk weight if they meet specified criteria. Velazquez then asked if Barr had met with financial institutions on the impact the proposed rule would have on their small business lending portfolios. Barr said the Fed welcomes comments from banks and that he met with banks on the proposed rule. She then asked Barr if he would be open to altering the proposal if presented with credible evidence that it would harm banks’ small business lending portfolios. Barr said the Fed is open to all kinds of improvements on the rule and welcomes any comments.

 

Rep. David Scott (D-Ga.) expressed concerns about the capital requirement increases on derivatives transactions through the proposal and asked Barr if his analysis for Basel III included the impact of the proposal on derivative end users and consumers. Barr said the derivatives proposals will improve the resilience of banks that are needed to provide the hedging services mentioned by Scott and that the proposal will benefit Americans that rely on derivatives. Scott asked Barr if there are adjustments, he can make to this proposal based on the concerns he is raising. Barr said the Fed is open to comments on the derivatives proposals and their effects on end users, noting that the Fed is willing to adjust the proposal as needed.

 

Rep. Bill Huizenga (R-Mich.) asked Barr if he had a sense of the cumulative impacts of Basel III endgame proposal and what effect it will have on consumers’ access to bank loan products. Barr said the Fed is looking at the overall impact of its rules but doesn’t anticipate that its proposals will have an impact on the consumer credit market. Huizenga followed up, asking if Barr would share the economic analysis that led him to begin creating the proposal. Barr said the analysis in the proposal is the analysis that supported the rule.

 

Rep. Emanuel Cleaver (D-Mo.) asked Barr’s opinion on whether banks today are sufficiently capitalized. Barr said the banking system is sound but noted that the Fed identified areas where improvement is needed within the proposal. Cleaver asked if the collapse of Silicon Valley Bank and other banks could have brought down the U.S. financial system. Barr said yes and that the Fed’s proposed capital requirements, specifically provisions that make banks account for unrealized losses in capital, would ensure a failure like Silicon Valley Bank’s would not happen again.

 

Rep. Ann Wagner (R-Mo.) asked if Gruenberg agreed that the Basel III endgame proposal will lead to higher credit costs and lower access to credit for traditionally underserved communities. Gruenberg emphasized that this is a proposed rule and said the FDIC plans address concerns on credit side in the final rule. He also noted that regarding the risk weights for mortgages, the proposal provides alternatives in the preamble that are being considered.

 

Wagner expressed concern about the US implementation of the Fundamental Review of Trading Book (FRTB) along with the global market shock component of the stress test which double count and require US banks to hold enough market risk capital for two financial crises while their European counterparts are only required to hold enough market risk capital for one. She asked if Barr believes that US banks are twice as risky as European banks or if European banks are undercapitalized. Barr said the proposal does not double count risks in the banking system and that the two components are done independently.

 

Rep. Jim Himes (D-Conn.) asked Barr to describe the quantitative methods that informed the capital rule proposal. Barr explained that capital is key to a strong banking system and helps to prevent financial crises. He noted the proposal focuses on trading and operational risk capital, where banks have had large losses in recent times. He said the proposal takes a standardized, but risk sensitive approach to credit and emphasized the Fed does not expect there to be major impact to the credit side as a result of this proposal.

 

Rep. Roger Williams (R-Texas) asked Barr if he would eliminate the proposal’s provision calling for the elimination of banks’ use of supervised internal models in determining capital requirements. Barr said the proposal will not have a significant effect on credit conditions, adding that the proposal keeps the current approach with respect to capital treatment for small bank lending.

 

Rep. Bill Foster (D-Ill.) asked Barr if he could walk the Committee through the number associated with the Basel III endgame proposal, mentioning that he had heard Barr say the increases would be 1.5-3 basis points while others are saying there will be a 20% increase in capital requirements. Barr said the overall proposed capital requirement increases will amount to 200 basis points (2%) and clarified that the 20% number that is quoted refers to a 20% increase from current capital requirements. Within that 200 basis points, 30(.3%) are associated directly with credit or with the operational risk that comes with credit provision.

 

Rep. Frank Lucas (R-Okla.) asked which financial weakness the Basel proposal is trying to address. Barr said the risk calibration that is used for certain banking activities does not match recent financial crises and explained that the rule seeks to address risks of some trading activities where the current calibration doesn’t address tail risks from these activities. Lucas asked Barr to commit to coordinating a financial analysis on Basel with Congress and CFTC. Barr said he welcomes any input on the proposed rule from any party.

 

Community Banks

Velazquez expressed concerns that there is confusion whether community banks would be affected by increases in capital requirements and asked if community banks are exempt from the Basel III endgame proposal. Barr said yes and that the rule only applies to roughly 40 of the largest banks in the country.

 

Rep. Blaine Luetkemeyer (R-Mo.) said the Durbin credit debit rule was cited by the GAO as having harmed checking account access. He continued, saying that research shows that merchants never lowered costs in the aftermath of the Fed’s rule and asked Barr if he is concerned about consumers paying more for services and small banks having to merge and close as a result of losing the income stream barred by this regulation. Barr said the proposed rule would not affect community banks and noted the Fed has directed regulators to ensure that debit cards are not subject to interchange fees. Harper said the NCUA looks at everything that affects credit unions and has determined the rule would only apply to larger institutions.

 

Williams asked Gruenberg to explain how federal agencies are working with community banks in complying with the Community Reinvestment Act. Gruenberg said the FDIC took great care to protect community banks in the Community Reinvestment Act rulemaking. He added that under the proposed rule, smaller community banks will be unaffected.

 

Trading and the SEC

Rep. French Hill (R-Ark.) asked Hsu and Barr whether they agree with the approach regarding the SEC’s custody rule. Hsu responded saying he has some concerns. Barr said the SEC’s proposal would represent a significant change in practices and that he has shared these concerns with the SEC.

 

Rep. Brad Sherman (D-Calif.) asked if any of the regulators are planning to hold banks accountable for the unrealized losses of securitized debt. Barr said the Basel III endgame proposal focuses on making banks account for unrealized losses on available-for-sale securities and that the Fed is open for comment on the proposal.

 

Wagner asked what specific analysis the Fed conducted on the impacts of the Basel III endgame proposal on securities underwriting. Barr said the Fed’s proposed rule would provide better risk calibration on a range of trading activities that banks conduct and will ensure that investors and depositors can have confidence in their bank.

 

Wagner asked Barr why he is placing punitive requirements on the trading desks of the largest financial institutions. Barr said some of the risks posed by some trading activities can cause serious losses in the banking and sector and cause significant harm to the economy. He said the Fed wants to ensure that all activities a bank undertakes are done in a safe and sound way and capital is the essential element to make sure banks operate safely.

 

Rep. Greg Meeks (D-N.Y.) asked how the Fed will address the proposal’s punishing of banks that sell affordable mortgages to GSEs. Barr said the Fed’s proposal requires operational risk for a range of market activities, including for securitization activities. He noted they are open to hearing concerns in this space and are willing to adjust.

 

Cryptocurrency and Digital Assets

Hill asked Hsu if he agreed that the OCC has are capable of effectively regulating the issuance of stablecoins. Hsu said yes. Hill also asked Barr to follow up on his letter regarding the Fed’s novel activities rule and asked if the non-objection status which he said would discourage banks from participating in stablecoins activities or other fintech activities is a problem as we want innovation in our banking system. Barr said that innovation is vital in the banking sector, but that his goal is to foster innovation while providing clarity to banks participating in novel activities and while keeping guardrails for safety and consumer protection.

 

Rep. Warren Davidson (R-Ohio) asked Barr about the status of his work on central bank digital currencies. Barr said the Fed is in the early stages of regulating digital currencies and added that if the Fed has a proposal for retail digital assets, they will come back to Congress to seek legislative authority to continue.

 

Davidson asked Hsu about the impact of the expiration of conditional approval for the trading of stablecoins by banks. Hsu said crypto and digital currencies have inherent risks and explained that the OCC’s guidance sought to ensure that banks were mitigating risks when trading digital assets.

 

China

Luetkemeyer asked Hsu if the OCC is developing a plan to mitigate risks to the US economy from potential sanctions on China in the event of a Chinese invasion of Taiwan. Hsu said the OCC holds regular conversations to assess risks to the banking system, spanning a range of topics. Luetkemeyer then asked if the OCC was putting together a plan for a set of sanctions in the event of an invasion of Taiwan. Hsu responded saying sanctions were not the OCC’s jurisdiction but that communication on these topics is crucial. Luetkemeyer also asked Harper and Gruenberg if they were involved in discussion about the impacts of such a scenario. Harper replied no and Gruenberg said he would get back to the Congressman.

 

Rep. John Rose (R-Tenn.) asked how we can be sure that the government of China is not playing an outsized role in setting international standards given Chinese regulators’ seat on the Basel committee. Barr said international organizations like Basel operate with consensus and said that if the US regulators felt that the proposals did not make sense, they would not adopt the regulations in the US.

 

 

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