Senate Banking Committee Hearing with Federal Reserve Vice Chair Quarles
Senate Banking Committee
“The Semi-Annual Testimony on the Federal Reserve’s Supervision and Regulation of the Financial System”
Thursday, November 15, 2018
Key Topics & Takeaways
- Regulatory Reform: Quarles said the Fed would be considering proposals for modernizing the resolution framework and for tailoring for foreign banking organizations (FBOs). He noted that he views tailoring for FBOs to be a separate question from implementation of S. 2155, in that domestic operations of FBOs are not “one for one” correspondent with domestic firms on the same size, but that the Fed needs to help ensure a level playing field. Regarding capital standards, Quarles said there are things the Fed can do to improve incentives, reduce regulatory burden, and transparency of regulatory expectations without undermining safety and soundness.
- Proposed Changes to Prudential Standards: Quarles said that the proposed changes to prudential standards would result in only a 2-2.5 percent reduction of liquidity in the financial system, and it is intended to tailor the burden of complying with regulation according to the riskiness of firms, calling this effort “appropriate.”
Witness
Opening Statements
Sen. Mike Crapo (R-Idaho), Chairman, Senate Banking Committee
In his opening statement, Crapo discussed some of the action the Federal Reserve (the Fed) has taken in implementing S. 2155, to include 19-month exam cycles and the small bank holding company policy statement. He spoke about the Fed’s proposed application of enhanced prudential standards, calling it a “step in the right direction,” adding that depending on where a firm lies within the four categories, certain enhanced prudential standards and capital and liquidity requirements are assigned. Crapo lauded the positive changes for regional banks, to include a reduced liquidity coverage ratio and stress tests, but raised concern over several issues that remain unaddressed, to include the treatment of foreign banking institutions, comprehensive capital analysis and review (CCAR), and resolution planning. He concluded that the Fed should “work promptly” to address such critical issues that remain outstanding.
Sen. Sherrod Brown (D-Ohio), Ranking Member, Senate Banking Committee
In Brown’s opening statement, he stressed the importance of the Fed ensuring Wall Street does not “crash” the financial system or “cheat workers out of savings,” noting that the agency “failed” 10 years ago to reign in the largest banks. He continued that since the crisis, regulations have been put in place to protect consumers and the system has become safer, though these regulations are currently being dismantled “piece by piece.” Brown noted that the Fed’s proposal to implement S. 2155 has gone “far beyond what the authors claimed the bill would do.
Testimony
The Honorable Randal Quarles, Vice Chairman for Supervision, Board of Governors of the Federal Reserve System
In his testimony, Quarles addressed the Fed’s efforts to improve regulatory transparency and their progress in making the post-crisis regulatory framework simpler and more efficient, including improving the supervisory rating system for large financial institutions to better align the rating with the supervisory feedback those firms receive. Quarles said the Fed expects to soon make final a set of measures to increase visibility into their stress testing program, including more granular descriptions of models, more information on the design of scenarios, and more details on projected outcomes. Quarles said that improving regulatory efficiency is also core to their efforts, and that tailoring regulation and supervision to risk is a programmatic goal. He noted that activities and firms that pose the greatest risk should receive the most scrutiny, and where risk is lower, so should be the regulatory burden.
Quarles noted that the Fed has released two recent proposals to better align prudential standards with the risk profile of regulated institutions. Quarles said the proposals would “significantly reduce” regulatory compliance requirements for firms in the lowest risk category, including most institutions with assets between $100-$250 billion in total assets. Quarles continued that the Fed expects to make progress on a number of issues, including simplifying and tailoring requirements under the Volcker Rule and working with their counterparts at the Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) on a community bank leverage ratio proposal.
Question & Answer
Regulatory Reform
Crapo asked what items are next on the Fed’s agenda and a status update for each. Quarles said the Fed would be looking at community bank leverage ratio proposals along with the OCC and the FDIC, and that he expects the proposals to be completely “very soon.” In response to a question from Sen. John Kennedy (R-La.) about the effect the proposal would have for a community bank with adequate capital, Quarles said those banks would not have less supervision, but would have “less paperwork.”
Quarles said shortly following that proposal, he expects the Fed to come out with proposals for modernizing the resolution framework and for tailoring for foreign banking organizations (FBOs). He noted that he views tailoring for FBOs to be a separate question from implementation of S. 2155, in that domestic operations of FBOs are not “one for one” correspondent with domestic firms on the same size, but that the Fed needs to help ensure a level playing field.
Brown asked if Quarles would guarantee that capital standards would not decrease from the levels they are today for “megabanks.” Quarles replied that the objective is not to have a material effect on the resiliency of the financial system or loss-absorbing capacity of the largest firms. Quarles said there are things the Fed can do to improve incentives, reduce regulatory burden, and transparency of regulatory expectations without undermining safety and soundness. He explained that beyond capital standards, it is important to look more broadly, and that it is possible to achieve a material improvement in efficiency and a reduction in cost while maintaining resiliency and strong loss-absorbency.
Sen. Bob Corker (R-Tenn.) said he strongly supports high capital levels to ensure safety and soundness, but that regulators should not be using it as a vehicle to manage bank profits. Quarles agreed, noting there are two principle concerns: safety and soundness of individual institutions and the system as a whole, and the efficiency of the system as a whole. Quarles said all citizens benefit from efficiency in the financial sector, as it provides support for economic growth and credit for businesses.
Stress Tests
Brown asked if the Fed is giving away a “cheat sheet” for stress tests through their transparency efforts. Quarles said that their transparency proposals have tried to strike a balance to improve the quality of models, but that if they were completely transparent, they could make the system more fragile rather than less, and that they are not being completely transparent for that reason.
Proposed Changes to Prudential Standards
Sen. Bob Menendez (D-N.J.) noted that the Fed recently proposed loosening liquidity rules for banks as large as $700 billion in total assets, adding that liquidity standards are “critical” to ensuring banks have “enough cash on hand” should there be stress on the market, and asked Quarles to justify these changes. Quarles replied that the proposal would result in only a 2-2.5 percent reduction of liquidity in the financial system, and it is intended to tailor the burden of complying with regulation according to the riskiness of firms, calling this effort “appropriate.” He added that the firms in question are generally funded with much less wholesale funding, and are generally much less subject to liquidity risk, noting that the Fed is under statutory instruction to tailor regulation.
Current Expected Credit Losses (CECL)
Sen. Doug Jones (D-Ala.) raised concern over unintended consequences of CECL that could impact the ability of banks to make long term loans, both residential and for small businesses. Quarles agreed that there is still an unknown about how CECL will operate in practice, explaining this is a reason for the three-year phase-in period that will allow the Fed to better understand the effects before it is included in the Fed’s capital calculations.
Government-Sponsored Entities (GSEs)
Corker asked if the GSEs are systemically important. Quarles said the GSEs are a complex problem that need a comprehensive solution rather than a piecemeal approach, but that they do have “systemic consequences.”
Community Reinvestment Act (CRA)
Jones asked about the Fed’s role in working with the OCC in their effort to modernize the CRA. Quarles said the Fed has worked with the OCC, noting they put out an advanced notice of proposed rulemaking (ANPR), and they will be looking at the information that comes in as part of that process as through their outreach, adding that he expects a joint rulemaking that reflects the comments they receive.
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