Senate Banking Committee Discusses Impact of Proposed Capital Rules

AT TODAY’S SENATE BANKING COMMITTEE HEARING, lawmakers discussed proposed interagency capital rules that seek to implement the Basel III framework with officials from the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC).

Chairman Tim Johnson (D-S.D.) opened the hearing by voicing his concern over the possible “adverse impacts” the proposed capital rules may have on small banks. In particular, he noted that the proposed risk weights may impact the ability of banks to offer mortgages and specifically questioned how the proposed rules will affect the housing market. In addition, Johnson stressed the importance of capital standards being well calibrated with other supervisory requirements and encouraged the regulators to take the “appropriate amount of time needed to get the rules right.”

Ranking Member Richard Shelby (R-Ala.) questioned the banking agencies’ ability to set appropriate capital levels, stating that such proposals should be supported by data and “rigorous” economic analysis. Shelby referenced a recent request he sent to the agencies asking for details on the data used to develop the proposal, including analysis on the anticipated compliance costs. He said the agencies responded to his letter yesterday, but criticized the response provided to him because it was based largely on data from the Basel Committee. He noted that such data aggregates results of countries; therefore the information does not explain the proposed rules’ impact specifically on the U.S.

Question and Answer

Both Johnson and Sen. Pat Toomey (R-Pa.) asked when final capital rules are expected, noting that the agencies recently announced it would not issue a finalized rule by the beginning of next year. John Lyons, Chief National Bank Examiner and Senior Deputy Comptroller, Bank Supervision Policy, for the OCC, did not provide an exact date, stating that the agencies received over 1,500 comments on the proposal and that it “will take time” to consider all the responses.

Johnson followed up by asking how engaged the regulators are with state and local insurance regulators with regard to developing the proposed rules. Michael Gibson, Director of the Federal Reserve’s Division of Banking Supervision and Regulation, said the Fed is working closely with a wide range of insurance experts and will “carefully consider” comments raised by the insurance industry as the agencies move forward with the rulemakings.

Sen. Bob Corker (R-Tenn.) voiced his “fascination” with how the proposed rules give sovereign debt a zero risk weighting unless a country goes into default. He pointed to the ongoing fiscal issues of the European Union (EU) and asked for an explanation as to “how we succumbed to a situation like this.” George French, Deputy Policy Director in the FDIC’s Division of Risk Management Supervision, said Corker raised an “important point” and noted how developing a method to assign grades is a challenge due, in part, to the fact that regulators cannot utilize credit ratings as directed under the Dodd-Frank Act. Corker asserted that regulators are “basically encouraging” firms to buy risky sovereigns. French noted that for practical purposes, this activity would largely be confined to the trading accounts of large banks. Gibson added that recent stress tests conducted by the Fed looked at potential losses of securities related to sovereigns, raising the point that other tools exists to ensure against excessive exposure to such debt.

Toomey echoed Corker’s concerns about the zero risk weighting of sovereign debt. He also inquired about the cost of compliance of the proposed capital rules for small banks with assets under $1 billion. French stated the FDIC concluded that compliance costs will have a “significant” impact on small banks. He added that comment letters are shedding more light on such costs and that the agency is working to address those concerns.

Sen. Michael Bennet (D-Colo.) discussed anecdotes from community bankers in his state about the difficulties such institutions are facing with regard to regulatory compliance costs and asked whether or not these issues are driving consolidation. He asked that the regulators ensure final rules do not have the effect of driving this type of consolidation. French assured the Senator that the regulators do not want to create a situation where compliance costs make a smaller bank uncompetitive.

Bennet followed up asking if the European banks were ready for these new capital reforms. Gibson replied that the EU is currently in the same phase as the U.S., adding that they do not yet have final rules in place and will also miss the implementation date of January 1, 2013.

Sen. Jack Reed (D-R.I.) asked if a great reliance on internal models is prevalent in the Basel III framework. Gibson explained that Basel III does not address this aspect but noted how the Basel Committee is conducting a study of how risk weights are put into practice, which will better inform regulators of any potential issues with the use of such models.

Sen. Sherrod Brown (D-Ohio) stated his opinion that the proposed leverage ratios are too low and asked if the regulators would consider establishing higher ratios on the largest banks. Gibson said that the Federal Reserve was in process of reviewing many comment letters and has not yet determined the best level for capital requirements. French and Lyons echoed Gibson’s response stating that it would not be appropriate to prejudge what those levels will be.


In his opening statement, Gibson provided an overview of the proposed changes to the regulatory capital framework for U.S. banking organizations. Gibson discussed the June 2012 interagency proposal to amend bank capital rules and attached the Federal Reserve’s impact analysis of this rulemaking. Noting how the regulators extended the comment period of the proposal to October 22, Gibson summarized the main concerns raised by comments from the financial industry, which focused on the treatments of accumulated other comprehensive income (AOCI) and residential mortgage exposures. He said the proposed treatment of AOCI is meant to “better reflect an institution’s actual loss-absorption capacity,” but noted that the Fed is analyzing commenters’ concerns and will be “assessing potential ways forward in this area as we finalize the rule.” In addition, Gibson highlighted a recent announcement issued by banking agencies which clarify that a final regulatory capital rule will not be published January 2013. He said the agencies are working “as quickly as possible to evaluate comments and issue a final rule that would provide the industry with appropriate transition periods to come into compliance.”

In his opening statement, Lyons discussed the proposed interagency capital rules and highlighted concerns from small and community banks over the proposal. These concerns include: the overall complexity of the proposals and questions about their applicability to, and appropriateness for, community banks; the proposed treatment of unrealized losses (and gains) in regulatory capital; and the treatment of real estate lending. Lyons emphasized that regulators are still in the process of reviewing all of the comment letters as well as the advantages and disadvantages of the suggested alternatives. In his testimony, Lyons attached the OCC’s impact assessment of the proposed capital rules.

In his opening statement, French provided an overview of the interagency proposal and pointed to a number of concerns that have been frequently raised by commenters. These concerns include the use of AOCI in the calculation of regulatory capital, the increased complexity and systems costs of the proposed new methods for asset risk weighting, and how the risk weights might interact with a number of pending mortgage regulations whose final form remains uncertain. French reiterated the fact that regulators are still considering all of the comment letters and stated that “we expect to make changes based on the comments.” French included in his testimony, the impact analysis of the proposed standardized approach.

For testimony and a webcast of the hearing, please click here.