Senate Banking on Capital and Liquidity
Senate
Banking Committee
Bank
Capital and Liquidity Regulation
Tuesday,
June 7, 2016
Key
Topics & Takeaways
-
Stress Test:Harvard Law Professor Hal Scott maintained that the Federal Reserve
could make the stress test process more transparent by issuing a notice of
proposed rulemaking (NPR) on the assumptions used in the model that are
critical to the outcome of the test, as well as the results of the model
evaluation conducted by a panel of experts.
- Hensarling Financial
Reform Bill: Sen. Warren (D-Mass.) characterized House Financial
Services Committee Chairman Hensarling’s (R-Texas) expected Financial CHOICE
Act as a “wet kiss for Wall Street” and doubted that it would end “too big to
fail” (TBTF) by repealing the Financial Stability Oversight Council’s (FSOC’s)
ability to designate systemically important financial institutions (SIFIs).
Catholic University Professor Schooner also refuted the notion that the bill
will end TBTF and argued that eliminating the SIFI designation process “won’t
make those risks disappear” but will only leave them “unchecked.”
Witnesses:
-
Professor Hal Scott,
Nomura Professor and Director of the Program on International Financial
Systems, Harvard Law School
- Dr. Marvin Goodfriend,
The Friends of Allan Meltzer Professor of Economics, Tepper School of Business
at Carnegie Mellon University
- Ms. Heidi Mandanis
Schooner, Professor of Law, Columbus School of Law, The Catholic University
of America
- Dr. Paul Kupiec,
Resident Scholar, American Enterprise Institute
Opening Remarks
Chairman Richard Shelby (R-Ala.)
Shelby
expressed his support for robust capital and liquidity standards to avoid
future financial crises, and explained that research shows that simple capital
standards better predict and mitigate bank failure than risk-based capital
standards. He expressed concern that regulators have not utilized a transparent
process to implement Basel III, and instead outsourced the production of impact
analyses to the Basel Committee. Further, he worried that regulators are
relying on an inadequate process through the Basel Committee that does not
account for the cumulative impact of regulations on market functioning. Shelby
argued that regulators must simplify unnecessarily complex rules, address
overlapping and counterintuitive rules, and take a holistic view of the regulatory
reform agenda so that they do not miss the “forest for the trees.”
Ranking
Member Senator Sherrod Brown (D-Ohio)
Brown
claimed that, in the lead up to the financial crisis of 2008, it appeared that
banks were meeting capital requirements but in reality had high levels of
leverage due to off-balance sheet exposures. He recalled that taxpayers “paid
the price for this reckless behavior” and reiterated the need for a strong
regulatory framework to undo the damage from the financial crisis.
Professor
Hal Scott, Nomura Professor and Director of the Program on International
Financial Systems, Harvard Law School
In
his remarks,
Scott maintained that the current regulatory framework does not allow
regulators to prevent the financial contagion that was experienced in 2008. He
underscored that the only way to stop contagion is for the central bank to use
its lender of last resort facility, which was curtailed through the Dodd-Frank
Act. In addition, Scott highlighted the main problem with the leverage ratio,
which he summarized as the fact that it requires the same level of capital
regardless of the riskiness of assets, and therefore induces investment in
high-risk assets which is inconsistent with robust risk management. He
explained that the inherent weakness in relying on the leverage ratio spawned
the risk-based approach adopted by Basel Committee. Scott also took aim at the
Federal Reserve’s (Fed’s) stress tests, which he said are not transparent since
they are not open to public evaluation.
Dr. Marvin Goodfriend, The Friends of Allan
Meltzer Professor of Economics, Tepper School of Business at Carnegie
Mellon University
In
his remarks,
Goodfriend expressed concern with the complexity of the Liquidity Coverage
Ratio (LCR), which he said is an “ill conceived” and “extraordinarily complex”
method to improve liquidity risk management in the banking system. He also
highlighted two significant operational problems with the LCR: 1) the level at
which the ratio is set may cause destabilizing scarcities of liquidity; and 2)
it encumbers liquid assets that banks would otherwise have access to use during
times of stress. Goodfriend maintained that monetary policy should ultimately
dictate the level of liquidity within the financial system, and that coupled
with the Fed’s ability to pay interest on reserves, it would be a “far less
burdensome” method to improve liquidity risk management in banks.
Ms. Heidi Mandanis Schooner, Professor of
Law, Columbus School of Law, The Catholic University of America
In
her remarks,
Schooner argued that sufficient equity capital is required to reduce systemic
risk and that current regulation is insufficient to safeguard the financial
system since equity capital levels “remain extremely low.” She recognized
the debate regarding the merits of using a risk-weighted capital system versus
a standardized approach, which she equated to “grading on a curve [. . .] so
pretty much everyone gets a B.” Schooner also argued that the
Comprehensive Capital Analysis and Review (CCAR) is “actually at odds with
prudential regulation” since it relies heavily on modeling future events, which
she said is foolish.
Dr. Paul Kupiec, Resident Scholar, American
Enterprise Institute
In
his remarks,
Kupiec urged policymakers to require regulators to simplify regulatory
requirements and make their rules “shorter.” He also expressed concern that
rules promulgated by the Basel Committee and Financial Stability Board are not
aligned with the goals set forth by Congress, as well as that the cost of
regulation does not factor in the cost to consumers, end-users, or the vitality
of the economy. Kupiec specifically took aim at the Fed’s proposed rules on
Total Loss Absorbing Capacity (TLAC), which he argued will not solve the “too
big to fail” (TBTF) problem. Kupiec explained that if the Treasury Secretary
cannot invoke Title II during the next crisis, TLAC resources would not be made
available to regulators.
Question and Answer
In
response to a question from Shelby, Scott maintained that the Fed could make
the stress test process more transparent by issuing a notice of proposed
rulemaking (NPR) on the assumptions used in the model that are critical to the
outcome of the test, as well as the results of the model evaluation conducted
by a panel of experts.
Cumulative
Impact
In
response to Shelby’s question regarding the complexity of the Basel III rules,
Kupiec agreed that even regulators have not figured out how the rules interact
and work on a bank management level.
Hensarling’s Financial Reform Bill
Sen.
Elizabeth Warren (D-Mass.) asked whether House Financial Services Committee
Chairman Jeb Hensarling’s (R-Texas) expected Financial CHOICE Act would end
TBTF by repealing the Financial Stability Oversight Council’s (FSOC’s) ability
to designate systemically important financial institutions (SIFIs). Schooner
refuted the notion that the bill will end TBTF and argued that eliminating the
SIFI designation process “won’t make those risks disappear” but will only leave
them “unchecked.”
Sen.
Merkley (D-Ore.) contended that Hensarling is leading an effort to deregulate
the banking sector to “stick [bank] losses” on everyday Americans.
Schooner
warned that policymakers should be cautious of promising broad-based
deregulation if banks increase capital levels.
Liquidity
in Zero Rate Environment
Sen.
Tim Scott (R-S.C.) asked about the performance of the Basel III liquidity rules
in a zero-rate environment. Kupiec explained that the liquidity
requirement discourages banks from holding deposits, which he said is a
“fundamental problem” that “mucks[s] at the heart of what it is to be a
banker.”
Liquidity
Crisis
Merkley
questioned whether the financial markets are experiencing a liquidity crisis,
which he characterized as a “false premise” disguised as an effort to bolster
support for financial de-regulation. Schooner posited that there is a
liquidity crisis but characterized it as a necessary spillover effect of
improving liquidity risk management in the banking sector. She argued
that policymakers should not be “alarmed” when they see “movements of this
kind.”
Improvements
to the Dodd-Frank Act
Senator
Rounds (R-S.D.) asked the panel what single change to the Dodd-Frank Act would
help make the financial system work better to serve the needs of the real
economy. Scott urged policymakers to reconsider the provisions that weakened
the Fed’s ability to act as the lender of last resort during a future
crisis.
Schooner
advocated for institutions holding more equity capital, as proposed in 2013 by
Sens. Brown and David Vitter (R-La.) in S. 798, the Terminating Bailouts for Taxpayer Fairness Act which
would require 15 percent capital.
Kupiec
emphasized the importance of regulatory simplification and transparency.
Additional
information about this event can be accessed here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Capital/Resolution Authority/SIFIs,Hearing Summaries Agency:Senate Banking Committee,Publish Year:2016
Senate
Banking Committee
Bank
Capital and Liquidity Regulation
Tuesday,
June 7, 2016
Key
Topics & Takeaways
-
Stress Test:Harvard Law Professor Hal Scott maintained that the Federal Reserve
could make the stress test process more transparent by issuing a notice of
proposed rulemaking (NPR) on the assumptions used in the model that are
critical to the outcome of the test, as well as the results of the model
evaluation conducted by a panel of experts.
- Hensarling Financial
Reform Bill: Sen. Warren (D-Mass.) characterized House Financial
Services Committee Chairman Hensarling’s (R-Texas) expected Financial CHOICE
Act as a “wet kiss for Wall Street” and doubted that it would end “too big to
fail” (TBTF) by repealing the Financial Stability Oversight Council’s (FSOC’s)
ability to designate systemically important financial institutions (SIFIs).
Catholic University Professor Schooner also refuted the notion that the bill
will end TBTF and argued that eliminating the SIFI designation process “won’t
make those risks disappear” but will only leave them “unchecked.”
Witnesses:
-
Professor Hal Scott,
Nomura Professor and Director of the Program on International Financial
Systems, Harvard Law School
- Dr. Marvin Goodfriend,
The Friends of Allan Meltzer Professor of Economics, Tepper School of Business
at Carnegie Mellon University
- Ms. Heidi Mandanis
Schooner, Professor of Law, Columbus School of Law, The Catholic University
of America
- Dr. Paul Kupiec,
Resident Scholar, American Enterprise Institute
Opening Remarks
Chairman Richard Shelby (R-Ala.)
Shelby
expressed his support for robust capital and liquidity standards to avoid
future financial crises, and explained that research shows that simple capital
standards better predict and mitigate bank failure than risk-based capital
standards. He expressed concern that regulators have not utilized a transparent
process to implement Basel III, and instead outsourced the production of impact
analyses to the Basel Committee. Further, he worried that regulators are
relying on an inadequate process through the Basel Committee that does not
account for the cumulative impact of regulations on market functioning. Shelby
argued that regulators must simplify unnecessarily complex rules, address
overlapping and counterintuitive rules, and take a holistic view of the regulatory
reform agenda so that they do not miss the “forest for the trees.”
Ranking
Member Senator Sherrod Brown (D-Ohio)
Brown
claimed that, in the lead up to the financial crisis of 2008, it appeared that
banks were meeting capital requirements but in reality had high levels of
leverage due to off-balance sheet exposures. He recalled that taxpayers “paid
the price for this reckless behavior” and reiterated the need for a strong
regulatory framework to undo the damage from the financial crisis.
Professor
Hal Scott, Nomura Professor and Director of the Program on International
Financial Systems, Harvard Law School
In
his remarks,
Scott maintained that the current regulatory framework does not allow
regulators to prevent the financial contagion that was experienced in 2008. He
underscored that the only way to stop contagion is for the central bank to use
its lender of last resort facility, which was curtailed through the Dodd-Frank
Act. In addition, Scott highlighted the main problem with the leverage ratio,
which he summarized as the fact that it requires the same level of capital
regardless of the riskiness of assets, and therefore induces investment in
high-risk assets which is inconsistent with robust risk management. He
explained that the inherent weakness in relying on the leverage ratio spawned
the risk-based approach adopted by Basel Committee. Scott also took aim at the
Federal Reserve’s (Fed’s) stress tests, which he said are not transparent since
they are not open to public evaluation.
Dr. Marvin Goodfriend, The Friends of Allan
Meltzer Professor of Economics, Tepper School of Business at Carnegie
Mellon University
In
his remarks,
Goodfriend expressed concern with the complexity of the Liquidity Coverage
Ratio (LCR), which he said is an “ill conceived” and “extraordinarily complex”
method to improve liquidity risk management in the banking system. He also
highlighted two significant operational problems with the LCR: 1) the level at
which the ratio is set may cause destabilizing scarcities of liquidity; and 2)
it encumbers liquid assets that banks would otherwise have access to use during
times of stress. Goodfriend maintained that monetary policy should ultimately
dictate the level of liquidity within the financial system, and that coupled
with the Fed’s ability to pay interest on reserves, it would be a “far less
burdensome” method to improve liquidity risk management in banks.
Ms. Heidi Mandanis Schooner, Professor of
Law, Columbus School of Law, The Catholic University of America
In
her remarks,
Schooner argued that sufficient equity capital is required to reduce systemic
risk and that current regulation is insufficient to safeguard the financial
system since equity capital levels “remain extremely low.” She recognized
the debate regarding the merits of using a risk-weighted capital system versus
a standardized approach, which she equated to “grading on a curve [. . .] so
pretty much everyone gets a B.” Schooner also argued that the
Comprehensive Capital Analysis and Review (CCAR) is “actually at odds with
prudential regulation” since it relies heavily on modeling future events, which
she said is foolish.
Dr. Paul Kupiec, Resident Scholar, American
Enterprise Institute
In
his remarks,
Kupiec urged policymakers to require regulators to simplify regulatory
requirements and make their rules “shorter.” He also expressed concern that
rules promulgated by the Basel Committee and Financial Stability Board are not
aligned with the goals set forth by Congress, as well as that the cost of
regulation does not factor in the cost to consumers, end-users, or the vitality
of the economy. Kupiec specifically took aim at the Fed’s proposed rules on
Total Loss Absorbing Capacity (TLAC), which he argued will not solve the “too
big to fail” (TBTF) problem. Kupiec explained that if the Treasury Secretary
cannot invoke Title II during the next crisis, TLAC resources would not be made
available to regulators.
Question and Answer
In
response to a question from Shelby, Scott maintained that the Fed could make
the stress test process more transparent by issuing a notice of proposed
rulemaking (NPR) on the assumptions used in the model that are critical to the
outcome of the test, as well as the results of the model evaluation conducted
by a panel of experts.
Cumulative
Impact
In
response to Shelby’s question regarding the complexity of the Basel III rules,
Kupiec agreed that even regulators have not figured out how the rules interact
and work on a bank management level.
Hensarling’s Financial Reform Bill
Sen.
Elizabeth Warren (D-Mass.) asked whether House Financial Services Committee
Chairman Jeb Hensarling’s (R-Texas) expected Financial CHOICE Act would end
TBTF by repealing the Financial Stability Oversight Council’s (FSOC’s) ability
to designate systemically important financial institutions (SIFIs). Schooner
refuted the notion that the bill will end TBTF and argued that eliminating the
SIFI designation process “won’t make those risks disappear” but will only leave
them “unchecked.”
Sen.
Merkley (D-Ore.) contended that Hensarling is leading an effort to deregulate
the banking sector to “stick [bank] losses” on everyday Americans.
Schooner
warned that policymakers should be cautious of promising broad-based
deregulation if banks increase capital levels.
Liquidity
in Zero Rate Environment
Sen.
Tim Scott (R-S.C.) asked about the performance of the Basel III liquidity rules
in a zero-rate environment. Kupiec explained that the liquidity
requirement discourages banks from holding deposits, which he said is a
“fundamental problem” that “mucks[s] at the heart of what it is to be a
banker.”
Liquidity
Crisis
Merkley
questioned whether the financial markets are experiencing a liquidity crisis,
which he characterized as a “false premise” disguised as an effort to bolster
support for financial de-regulation. Schooner posited that there is a
liquidity crisis but characterized it as a necessary spillover effect of
improving liquidity risk management in the banking sector. She argued
that policymakers should not be “alarmed” when they see “movements of this
kind.”
Improvements
to the Dodd-Frank Act
Senator
Rounds (R-S.D.) asked the panel what single change to the Dodd-Frank Act would
help make the financial system work better to serve the needs of the real
economy. Scott urged policymakers to reconsider the provisions that weakened
the Fed’s ability to act as the lender of last resort during a future
crisis.
Schooner
advocated for institutions holding more equity capital, as proposed in 2013 by
Sens. Brown and David Vitter (R-La.) in S. 798, the Terminating Bailouts for Taxpayer Fairness Act which
would require 15 percent capital.
Kupiec
emphasized the importance of regulatory simplification and transparency.
Additional
information about this event can be accessed here.