Implementing Basel III: What’s the Fed’s Endgame

House Financial Services Committee
Subcommittee on Financial Institutions and Monetary Policy
Implementing Basel III: What’s the Fed’s Endgame
Thursday, September 14, 2023 

Topline

• Democrats asked questions about how to strengthen the financial system and approach the issue of capital levels to ensure that Americans and small/regional banks do not suffer from consequences of congressional or federal action.
• Republicans expressed concerns about the negative impacts on the implementation of the proposals and how it may hurt an already struggling economy.

Witnesses

• Mr. Greg Baer, President and CEO, Bank Policy Institute
• Mr. Andrew Olmem, Partner, Mayer Brown
• Mr. Robert Broeksmit, President and CEO, Mortgage Bankers Association
• Ms. Alexa Philo, Senior Policy Analyst, Banking, Systemic Risk, Economic Justice & Racial Equity, Americans for Financial Reform

Opening Statements
Subcommittee Chairman Andy Barr (R-Ky.)
In his opening statement, Barr said that the Basel III proposal is underdeveloped, misleadingly motivated, and was written behind closed doors principally by the Fed’s Vice Chair. He noted that the proposal would put the US ahead in a race to a gold-plated top for global capital requirements and would push the US to the bottom for global competitiveness. Barr also criticized the proposal for its lack of a convincing foundation, and said it is cynical to put forward as a rationale for the non-credible evaluation of March banking instability authored and engineered solely by the Vice Chair for Supervision at the Fed. He closed by saying during a time of inflation, the fastest increases in interest rates in modern history, and a growing likelihood of a credit crunch, now is not the time to raise capital levels.

Subcommittee Ranking Member Bill Foster (D-Ill.)
In his opening statement, Foster noted that the proposals modify capital requirements for US banks with the goal of ensuring that they appropriately account for risks. He said that throughout the passage and implementation of Dodd-Frank and initial implementation phases of Basel III, many predicted that the higher capital requirements would damage the competitiveness of the banking industry in the US. Foster noted that in an age of rapid financial innovation, internet-driven banks, rising geopolitical tensions, pandemics, and climate change, regulators and Congress must respect the lessons learned from the financial crisis of our past. He closed by saying that it’s important that the public has maximum visibility into both the rules themselves and into the quantitative consideration that led to the final choice.

Committee Chairman Patrick McHenry (R-N.C.)
In his opening statement, McHenry said that banking regulators had the opportunity to learn from the March banking instability and the chance of productively engaging with Congress, but instead they took advantage of a crisis to justify their long-held politically motivated priorities. He closed by asking to see a thorough economic analysis from the Federal Reserve.

Committee Ranking Member Maxine Waters (D-Calif.)
In her opening statement, Waters noted that the proposals would implement an international agreement that the US made with other countries in 2017, which Trump’s regulators ignored. She closed by asking for stronger rules, not regulation, to avoid more economic crises.

Testimony
Mr. Greg Baer, President and CEO, Bank Policy Institute
In his testimony, Baer said congressional attention is important in this scenario given the stakes for the US economy. He touched upon the bank failures of March 2023 and explained that they failed due to interest rate risk and liquidity risk. He noted that no US bank had adopted the internal model approach to capital assessment by the 2008 financial crisis, and that studies have found that non-financial firms cut lending by about 50% more than banks in the face of financial shocks. He closed by saying that the proposal lacks an explanation for how risk weight was derived and ignores reality.

Mr. Andrew Olmem, Partner, Mayer Brown
In his testimony, Olmem said the proposal will have substantial long-term consequences for American households, businesses, and the overall economy. He noted that the proposal disregards Congress’ mandates governing capital requirements and that the problematic nature of the proposal is particularly consequential because capital requirements are among the most important regulations in economic policy. Olmem said that capital requirements ensure that the banking system is safe and sound, but also should influence the allocation of credit, determining if and on what terms credit is extended and by whom. He closed by noting that the rush to complete this proposal has left key questions unanswered

Mr. Robert Broeksmit, President and CEO, Mortgage Bankers Association
In his testimony, Broeksmit said that proposal will cause unwarranted risks to the economy, housing, and real estate markets. He mentioned that it is still unclear how the NPR interacts with other regulatory proposals, and how these rules collectively could stunt economic growth and credit access needed to support the creation of more affordable housing from the largest providers of capital in the country. Broeksmit also noted that large increases in capital standards will likely stunt macroeconomic growth. He closed by noting that the proposed changes effectively increased capital requirements at larger banks by about 15-20%, with he noted are large enough to impact which lines of business banks choose to support or withdraw from.

Ms. Alexa Philo, Senior Policy Analyst, Banking, Systemic Risk, Economic Justice & Racial Equity, Americans for Financial Reform
In her testimony, Philo said the proposals will strengthen a bank’s ability to withstand stresses that can otherwise imperil a bank’s financial viability and hurt depositors and customers in the economy. She warned members that the US continues to have a dangerous combination of under capitalization of some products and compensation practices that incentivize outside risk taking. Philo noted that without the right standards, a bank can look great on paper but lack a sufficient capital cushion. She closed with saying more robust capital standards reduce the risk of financial crises which research shows are longer and more damaging than other recessionary periods and have a disproportionate impact of Black and Latinx Americans. 

Question & Answer
Small and Regional Banks/Businesses
Barr asked what the impact would be on the regional banking sector. Baer said that regional banks are currently well-capitalized, but their challenge currently is earnings, especially at a time when deposit costs are rising, and loan rates are not.

Waters asked Philo to confirm whether the proposal applies to community banks. Philo said it does not apply to community banks.

Rep. John Rose (R-Tenn.) asked Olmem if he was worried about the lack of tailoring of the proposal and if it will drive consolidation among regional banks to achieve the scale needed for compliance. Olmem said that it’s a serious issue that he hasn’t seen addressed.

Rep. Young Kim (R-Calif.) asked how new regulations could impact access to capital for small businesses. Baer said that he is unsure since his company has not analyzed CRA credit yet.

Cost-Benefit Analysis of Proposals and Impacts of Proposals
Barr also asked Olmem if given the administration law fouls the Fed made while was still molding the proposal and collecting data, whether the Fed should’ve issued an ANPR to allow experts the ability to provide input. Olmem said that these fouls are not just technical process problems, they are statutory violations and that the Fed was obligated to give the public the opportunity to provide feedback.

Rep. Bill Posey (R-Fla.) asked what Baer thinks of the Fed’s cost-benefit analysis of the proposals. Baer said that there is no rigor whatsoever and that there were no numbers in their analysis.

Rep. Blaine Luetkemeyer (R-Mo.) asked if it is a good idea to implement Basel III standards, which are European standards, on American banks and banking industry. Baer said that there is a notion that there should be an international accommodation with respect to capital standards.

Rep. Brad Sherman (D-Calif.) asked if the proposal would have an impact on the ability to meet standards of the Inflation Reduction Act, specifically regarding climate change. Philo said there would be no change in the ability.

Rose asked Olmem if Basel III could negatively impact securitization in the US economy and capital markets. Olmem suggested it could be negative.

Housing and Mortgages
Luetkemeyer asked Broeksmit what the cost would be for consumers, banks, and lenders in the home mortgage market. Broeksmit said that the cost to consumers is that there’ll be fewer sources of mortgage financing.

Sherman asked if there was going to be no credit for mortgage insurance. Broeksmit said that that makes no sense at all.

Rep. Roger Williams (R-Texas) asked Broeksmit to elaborate on the effects that Basel III will have on the mortgage market, and if the US will see heightened consequences in an already struggling market out there. Broeksmit said that the US will see heightened consequences.

Rep. Gregory Meeks (D-N.Y.) asked Broeksmit to provide more background on what the Special Purpose Credit Programs are, and if it will be affected at all by the proposal. Broeksmit said the Special Purpose Credit Programs make it easier for groups that have historically been disadvantaged in the home-buying process to get loans. He also said this proposal would increase the amount of capital an individuals would have to retain on loans with less than 20% down.

Rose asked Broeksmit if he agrees that the proposal will make home affordability worse. Broeksmit agreed.

For more information on this meeting, please click here.
For an archive of past SIFMA hearing coverage, please click here.