Senate Banking Committee
“The Semiannual Monetary Report to Congress”
Tuesday, June 21, 2016
Key Topics & Takeaways
- Stress Tests: Chairman Shelby (R-Ala.) asked about the Federal Reserve’s stress tests and whether it will make changes to exempt regional banks from their qualitative aspects. Yellen answered that the Fed is engaging in a five-year review and that she expects to see “meaningful changes,” including possibly exempting banks with $50-$250 billion in assets from stress tests’ qualitative aspects.
- Capital and Liquidity Requirements: Ranking Member Brown (D-Ohio) asked whether the Federal Reserve’s approach to capital and liquidity requirements for the largest banks has made the financial system stronger. Yellen responded that she believes the requirements have made “an enormous difference” in the safety and soundness of the financial system. She specifically pointed to the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) as measures that have enhanced financial stability and contributed to a less crisis-prone system.
- Living Wills: Sen. Elizabeth Warren (D-Mass). opined that the banks are unlikely to make necessary changes to their living wills unless they believe the regulators are serious about enforcing the deadline by imposing higher capital standards. Yellen responded by stating that the Federal Reserve is “extremely serious” in its review of living wills and has identified specific changes it wants to see. However, she said she cannot commit to exactly what the response to inadequate plans would be.
In his opening statement, Chairman Richard Shelby (R-Ala.) stated that the semiannual monetary policy hearings are not sufficient to give Congress and the American people full transparency into the Federal Reserve’s policymaking process. While he noted that politics have no place at the Federal Reserve and that the Federal Reserve should act independently of Congress and the Administration, he argued the Fed’s policy should be clear and unambiguous. Additionally, he noted that some experts have argued that better disclosure about monetary policymaking would made the Federal Reserve more independent.
Shelby further commented that the Federal Reserve’s regulatory conduct is becoming increasingly opaque and complex, especially regarding the Basel rules, which he claims were imposed on domestic institutions without adequate tailoring. Shelby criticized that, rather than conducting its own analysis as it did for Basel I and Basel II, the Federal Reserve relied on Basel Committee studies. He argued the Federal Reserve should perform a rigorous analysis of each individual rule, as well as look at the cumulative impact of financial regulations. Shelby then suggested the United States should follow the European Commission, which has looked at the interaction of regulations to assess cumulative impact.
Ranking Member Sherrod Brown (D-Ohio), in his opening statement, noted the modest economic gains since the last monetary policy hearing. Brown criticized some of his Republican colleagues, as he argued they are undermining the safeguards that dampened the economic crisis and are needed to prevent the next one. He opined that the Republicans politicize and undermine the Federal Reserve and want turn the U.S. into the “Casino Capitalist” by repealing Dodd Frank.
Specifically, Brown criticized presumptive Republican presidential nominee Donald Trump, saying he is “a factory of bad ideas” and that his policies would be destructive and would weaken our economy.
In her testimony, Chair Janet Yellen of the Federal Reserve Board of Governors highlighted progress made towards the Federal Reserve’s objective of maximum employment, with 14 million jobs created since early 2010 and the unemployment rate having fallen more than 5 percentage points from its peak. Additionally, she stated how jobless rates have declined for all major demographic groups, yet she still highlighted the concern that unemployment rates for minorities remain higher than for the nation overall.
Moving on to inflation, Yellen discussed how although the inflation rate is short of the Committee’s 2 percent objective, the price index for personal expenditures increased 1 percent over the 12 months ending in April, up notably from its pace of last year. She stated that the Committee expects inflation to rise to 2 percent over the medium term. She then discussed how the Committee is closely monitoring global economic and financial developments, such as the U.K. referendum to exit the European Union, and watching the slowing growth in China, to look at their implications for domestic economic activity, labor markets, and inflation.
Turning to monetary policy, Yellen noted that the FOMC has maintained the target range for the federal funds rate at ¼ to ½ a percent and has kept the Federal Reserve’s holdings of longer-term securities at an elevated level. She stressed that proceeding with caution will allow the United States to support economic growth while assessing whether growth is returning to a moderate pace. Yellen said the FOMC anticipates that economic conditions will evolve in a manner that will warrant “only gradual increases” in the federal funds rate, and that the federal funds rate is likely to remain below “levels that are expected to prevail in the longer run” for a while.”
Questions and Answers
Shelby asked about the utility of the Federal Reserve’s forward guidance over the past several months. Yellen answered that the Fed has used forward guidance less than in the aftermath of the financial crisis, but that projections from FOMC participants every three months are sometimes thought to constitute this forward guidance. She explained that these projections are helpful to the public in understanding the path of the economy, but stressed that they are “not in any way” a commitment to any monetary policy path.
Shelby noted a report from the Bank for International Settlements (BIS) that suggested long periods of low rates can be damaging to the economy by contributing to costly booms and busts. He asked if Yellen agrees that persistently low rates can have negative effects. Yellen replied that the current period of low rates has been critical to economic progress, but admitted that it can lead to investors reaching for yield. She said the Federal Reserve is very attentive to this possibility, but that she does not believe the threat to financial stability is elevated at this time.
Sen. Bob Corker (R-Tenn.) commented that the Fed has “basically announced that we have embarked on [Quantitative Easing] 4” by reinvesting proceeds that investments that reached maturity in new securities. Yellen retorted that this is not a policy change, and that the FOMC has been clear that it would continue to reinvest proceeds. She added, however, that eventually a day will come when the FOMC will allow securities to run off the balance sheet.
Corker recalled that Yellen said during her last appearance before the Committee that her staff was looking into whether the Federal Reserve has the legal authority to employ negative interest rates. Yellen answered that she believes the Fed does have the authority to pursue negative rates, but that it is not considering doing so.
Senator Robert Menendez (D-N.J.) mentioned that some people had proposed reducing the national debt by asking creditors to accept a haircut, and asked what the consequences of such a haircut would be. He also asked if it is true that U.S. households and entities own the majority of U.S. debt. Yellen responded that the consequences of the U.S. defaulting on its Treasury debt would be severe and harmful to U.S. interests, and at a minimum would result in higher borrowing costs for households and businesses.
Senator Pat Toomey (R-Pa.) inquired about the limits of monetary policy, asking if Yellen agrees with her predecessor, former Chair Ben Bernanke, that accommodative monetary policy only stimulates shifts in the timing economic activity. Yellen answered by stating that the stance of policy also has repercussions with a more lasting impact on the state of demand.
Senator Jeff Merkley (D-Ore.) asked about the conflicts of interest regarding commodities and the banks’ abilities to own warehouses, factories and mines. He argued this was unfair and asked if there was anything the Federal Reserve planned to do about it. Yellen responded that the Federal Reserve will come out with a proposal on it, but a big part of this comes from decisions Congress made.
Shelby asked about the Federal Reserve’s stress tests and whether it will make changes to exempt regional banks from their qualitative aspects. Yellen answered that the Fed is engaging in a five-year review and that she expects to see “meaningful changes,” including possibly exempting banks with $50-$250 billion in assets from stress tests’ qualitative aspects.
Shelby asked about the implications of the United Kingdom leaving the European Union. Yellen said it would be significant for the U.K. and the European Union as a whole, and that it could usher in a period of uncertainty and financial volatility.
Sen. Dean Heller (R-Nev.) asked for more details on the repercussions if Britain were to leave the EU. Yellen responded that it could have significant economic consequences by launching a period of economic uncertainty about the future of European economic integration. She discussed the potential impact on the financial markets, including a flight to safe haven currencies, but added that it was not likely to cause a U.S. recession.
Sen. Tom Cotton (R-Ark.) asked if Yellen would take a position on the vote. She responded saying she would not take a position, but repeated that it could have consequences for the U.S. economic outlook.
Cotton also asked if the Federal Reserve was ready for all contingencies, to which Yellen responded the Federal Reserve will closely monitor the economic consequences and is prepared to act as necessary.
Capital and Liquidity Requirements
Brown asked whether the Federal Reserve’s approach to capital and liquidity requirements for the largest banks has made the financial system stronger. Yellen responded that she believes the requirements have made “an enormous difference” in the safety and soundness of the financial system. She specifically pointed to the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) as measures that have enhanced financial stability and contributed to a less crisis-prone system.
Sen. Jon Tester (D-Mont.) pointed to the consolidation of small banks across the U.S. and asked if there is a problem with the regulatory regime for small banks. Yellen said the Federal Reserve is very heavily focused on efforts to remove regulatory burdens on small banks and that the agency tries to tailor regulations for entities based on their size and risk. She then said the Federal Reserve is looking into a significant simplification of the capital regime and that a number of factors have contributed to the consolidation among small banks.
Shelby asked if the Federal Reserve was examining the reports that custody banks have turned away deposits or are charging fees on deposits because of the enhanced supplementary leverage ratio (SLR). He also asked if the rule increases systemic risks during times of stress. Yellen responded that the Federal Reserve is aware of the concerns about SLR affecting custody banks’ profitability, and that leverage ratios are normally intended to be a backup form of capital regulation that is not oriented toward the risk of particular assets. She said the Federal Reserve will monitor this, but it is the way leverage ratios have always been imposed.
Corker commented that he was confused that Governor Jerome Powell recently stated that the Fed’s raising of capital requirements may force banks to downsize themselves. He asked whether the Fed intends to restructure institutions that fail to submit credible living wills, or push them to do so themselves through higher capital and liquidity requirements. Yellen simply explained that if firms fail to address deficiencies in their plans, Dodd-Frank gives the Fed power to either impose higher capital requirements or to require structural changes. She said the Fed is insisting that the firms address all identified shortcomings.
Sen. David Vitter (R-La.) asked Yellen if she agreed that the federal government would have to step in to support the largest banks in case of their failure. Specifically, he asked what the banks that failed to submit credible living wills had to do to address their deficiencies, and whether the Federal Reserve would raise capital requirements for them if they did not sufficiently address them the shortcomings by the October 1 deadline. Yellen responded by stating that the banks have greatly improved their resolution plans, though she could not guarantee what course of action would be taken if the banks failed to meet the October 1 deadline.
Sen. Mark Warner (D-Va.) expressed his concern over the levels of disagreement between the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) on living wills.
Sen. Elizabeth Warren (D-Mass). also expressed concern about the non-credible living wills submissions. She noted that the Federal Reserve and FDIC have the power to raise both capital standards and leverage ratios, arguing that these changes are critical to avoid another crisis, but opined that the banks are unlikely to make necessary changes unless they believe the regulators are serious about enforcing the deadline. She asked Yellen if she would commit to have the Federal Reserve use the powers Congress gave it if banks fail to address their plans’ deficiencies by October. Yellen responded by stating that the Federal Reserve is “extremely serious” in its review of living wills and has identified specific changes it wants to see. She said she cannot commit to exactly what the response would be.
Warren argued that the banks have known about the requirements for the living wills since 2010 and that if any fail the credibility test on their fifth try, they “need to face serious consequences.” Yellen affirmed that there will be consequences.
Warren stressed that the entire goal of the living will process was to end the “too big to fail” problem. She said she was glad the Federal Reserve finally called some plans non-credible, but declared it will not mean anything if the Federal Reserve will not use its powers to impose higher capital standards.
Sen. Jack Reed (D-R.I.) asked if the Federal Reserve has the authority to require regulated entities to have cybersecurity expertise on their boards, or to make disclosures about a cybersecurity strategy. Yellen said the Federal Reserve regards cybersecurity as a significant threat and includes it in its examinations, but that she has not looked at the question of board membership.
Warner was interested in learning whether the United States can ensure under prudential regulations that bank boards have cyber expertise within their membership, and he argued the need to work closely with the whole banking industry
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