Senate Committee on Banking, Housing, and Urban Affairs: The Financial Stability Oversight Council Annual Report to Congress
Senate Committee on Banking, Housing, and Urban Affairs
The Financial Stability Oversight Council Annual Report to Congress
Thursday, February 8, 2024
Topline
- Democrats asked Yellen about increased capital requirements for large banks and how Basel III would impact community banks and consumers.
- Republicans voiced concerns that the Biden Administration has hurt the economy and that there should be stronger sanctions in place against foreign adversaries, such as Iran.
Witnesses
- The Honorable Janet L. Yellen, Chair, Financial Stability Oversight Council (FSOC)
Opening Statements
Committee Chairman Sherrod Brown (D-Ohio)
In his opening statement, Brown applauded Yellen and the Biden Administration for their work on fixing the post-pandemic economy. He also recalled how essential FSOC has been in regulating Wall Street and banks since its implementation in the Dodd-Frank Act, and particularly during the bank failures in March 2023. Brown reminded Committee members that FSOC’s job is also to close gaps in the US financial system by covering blind spots that any one agency may have.
Brown further criticized Wall Street by saying that it’s not a surprise that Wall Street and its wealth-funded allies have always wanted to kill anything that tries to hold it accountable, including FSOC regulations. He said that FSOC could bring oversight and accountability to parts of Wall Street that continue to operate in the dark, and that FSOC is currently in a good position to make sure that bad bets don’t happen anywhere in Wall Street. Brown closed by mentioning that FSOC is monitoring how commercial property markets are affecting the US banking system.
Committee Ranking Member Tim Scott (R-S.C.)
In his opening statement, Scott criticized Yellen and the Treasury Department for sending money to foreign adversaries, like Iran. He also criticized Yellen’s work in the Treasury, saying that inflation is a crisis brought to Americans by the Biden Administration and people who philosophically believe that a bigger government somehow leads to more success. He further focused on the money the US sent to Iran and noted that he, along with 24 of his Republican colleagues, sent Yellen a letter demanding answers on how she could continue to provide Iran with billions of dollars that knowingly fund terrorism throughout the Middle East.
Scott continued to shame the Biden Administration’s policies, which he said have shifted America from a position of strength on the world stage to a position of weakness for all to see. He called for action on a national level and asked Yellen to use economic tools to stop the flow of fentanyl coming into the country. Scott closed by saying Yellen, as FSOC Chair, has the responsibility to improve the economy, protect Americans, and lead Americans to a better future, yet instead, Congress has seen proposals that allow for the federal government to spy on American accounts.
Testimony
Janet Yellen, Secretary, Department of the Treasury
In her testimony, Yellen discussed the economic recovery that the Biden Administration has driven over the past three years. She highlighted solid GDP growth, a decline in inflation, and a healthy labor market. She recognized that these developments are part of the reason that families are now able to put more money back into the economy. She claimed that without a continuously stable and strong US financial system, there would not have been economic growth at the levels seen today.
Yellen recognized the work FSOC has completed over the last year, stating the monitoring of a wide range of risks by FSOC. These risks included commercial and residential real estate sectors, global geopolitical conflicts, and technological developments. She also said during the bank failures of March 2023, FSOC reacted quickly to prevent contagion to banks with similar vulnerabilities and to maintain confidence in the banking system. Yellen noted FSOC if seeking to improve transparency with the issuing of an analytic framework that, for the first time, will provide the public with in-depth information on how FSOC monitors, assesses, and responds to potential risks.
Yellen noted that FSOC supports member agencies’ plans to review whether capital measures appropriately reflect a banking institution’s ability to absorb losses, improve resolvability at large, complex, or interconnected banks, and address any vulnerabilities from uninsured deposit levels and depositor composition. She noted that FSOC is also focused on member agencies’ enhancing assessment efforts and increasing coordination around climate change-related financial stability risks from increasingly severe and frequent climate events. Yellen said FSOC is closely monitoring the increasing use of artificial intelligence in financial services. She noted that AI brings potential benefits, such as reducing costs and improving efficiencies, and potential risks, like cyber and model risk. Yellen closed by asking Congress to pass legislation to regulate stablecoins and the spot market for crypto assets that are not securities, as she is limited in her role with what she can do without legislation.
Question & Answer
Foreign Adversaries and Sanctions
Sen. Jack Reed (D-R.I.) asked if some investment advisers are taking money from Russians, Chinese, etc. and moving it through hedge funds and essentially washing it here in the U.S. Yellen said this was true.
Scott asked Yellen how Treasury continues to provide Iran with billions of dollars knowing that they are behind attacks against US servicemembers. Yellen argued that Treasury has been extremely aggressive and very vigilant about sanctions on the Iranian regime and that Treasury has taken many actions in the aftermath of the attacks on Israel to close channels for Hamas and other Iranian-affiliated groups to use the financial system. She closed by acknowledging the billions of dollars Scott referred to were Iranian funds that were frozen in Korea.
Sen. Jon Tester (D-Mont.) asked if the US has a good enough handle on where threats from foreign adversaries are directed. Yellen clarified that FSOC is only concerned with threats to the US financial system, but that China poses several threats that the Biden Administration and Treasury are concerned about.
Sen. Mark Warner (D-Va.) asked Yellen if she thinks legislation is needed to make sure that all foreign terrorist groups are barred from using cryptocurrency. Yellen said that Treasury faces limitations and that she would support a proposed bill.
Sen. Katie Britt (R-Ala.) asked how long it took for the Biden Administration to learn about the financers of the October 7th attack. Yellen said that the Administration had focused on Hamas and similar organizations but had been acting on sanctions before the attacks. She added that the US is currently cracking down on Iran with respect to oil shipments.
Sen. Chris Van Hollen (D-Md.) asked Yellen about the progress being made in the broader area of how US foreign adversaries use investment advisers. Yellen said investment advisors have not been uniformly covered by AML-CFT requirements. She added that there are some investment advisors or brokers who may be covered by some rules, but there are certainly investment advisors that are not covered. She closed by noting that Treasury expects to issue a proposed rule on this soon.
Basel III Endgame and Capital Requirements
Brown referenced the failing of banks in March of 2023 and asked how, when our banking system faces unexpected stresses, strong capital rules reduce systemic risk and help to protect depositors. Yellen said capital can absorb losses from unanticipated shocks and strong capital enables banks to remain viable and not fail. She said that in a rising interest rate environment, poor risk management can lead to realized and unrealized losses for banks. Yellen said that Silicon Valley Bank had enormous uninsured deposits and inadequate liquidity then when they had some losses, it triggered a run which threatened runs at other institutions that had exposure to uninsured deposits. She said that after this, measures were taken by the President, the Treasury, and the regulators to try to stem a systemic bank run which she thinks were successful.
Sen. Mike Rounds (R-S.D.) asked Yellen if she believes that US banks continue to have sound levels of regulatory capital and healthy levels of profitability while maintaining ample liquidity buffers. Yellen agreed.
Rounds then asked Yellen if she would discuss Basel III. She declined. He noted after that if banks have sound levels of regulatory capital and healthy levels of profitability while maintaining ample liquidity buffers, he doesn’t think the US needs a whole lot of additional changes regarding the Basel III endgame.
Sen. Elizabeth Warren (D-Mass.) stated that the Fed has proposed increased capital standards to make the giant banks hold more capital, and that even among the billion-dollar banks, nearly 90% already hold enough capital. Warren then asked Yellen if the Basel III endgame proposal would have no impact on community banks and would only make a handful of giant banks hold more capital. Yellen said that its terms only apply to banks with more than $100 billion or significant trading activities, and community banks have far lower assets than that threshold.
Warren asked why it’s important for these giant banks to hold more capital. Yellen clarified that capital is a measure of the resources a bank has to absorb losses in the face of a shock. She added that, even in normal times, capital is something a bank must have to lend, so it’s critical to meeting the borrowing needs of households and businesses throughout the economy. She said when a shock hits, like we saw in the financial crisis, a bank can fail and, if it is large bank or highly interconnected, its failure can have devastating consequences for the financial system. The failure of one bank can transmit many problems to other banks that they lend to or borrow from, causing them to fail and leading to a financial crisis. She said that when you have a financial crisis, it can cause an enormous economic toll hitting hard working Americans and businesses that did not have anything to do what caused it, also increasing unemployment.
Warren then asked if higher capital standards are to ensure that both banks and consumers are safer. Yellen agreed because it diminishes the odds of a systemic failure. Warren closed by talking about how now, less than year after three banks collapsed, New York Community Bank is now teetering. She said that regulators are just trying to make sure that these giant banks don’t go broke and come to the taxpayers for a bailout, like they have done before.
Warren said that higher capital requirements might mean fewer stock buybacks and somewhat smaller bonuses for the CEOs but said that giant banks are saying that they will stop making mortgage loans if they have to hold more capital. She then asked the rhetorical question of who could trust them. She encouraged regulators to finalize Basel III as soon as possible.
FSOC Designation Authorities and Risk Identification
Brown asked Yellen to clarify why FSOC designation authorities are important for ensuring that Wall Street is accountable when it puts the US financial system at risk. Yellen referred to 2008 and mentioned how some investment banks, such as Lehman Brothers, were not investment banks but instead shadow banks or non-bank financial institutions. She added that these institutions had very little capital and were highly leveraged. She said that their failure caused a devastating financial crisis that took almost a decade to recover from. Yellen said that FSOC must make sure that they recognize non-banks because they can pose risks to the financial system.
Scott claimed that companies are currently have a difficult time figuring out when they are threatened and when they are not threatened of becoming a systematically important financial institution (SIFI). Yellen said that FSOC revised the 2019 guidance because it made it impossible to designate a firm as a SIFI and deprived FSOC of a tool that Congress, in Dodd-Frank, clearly intended for it to have. She added that Dodd-Frank does not require a cost-benefit analysis because the cost is to individual firms, and the benefit is a reduced probability of a devastating financial crisis which is very hard to quantify. She reassured Scott that there is no preference for designation. Scott said that only the government thinks that figuring out the cost of something is unnecessary and determining the activities that lead to a threat is unnecessary.
Sen. Catherine Cortez Masto (D-Nev.) asked if FSOC’s shift away from banks to non-banks poses a financial stability risk due to non-banks lacking access to deposits for short-term financing. Yellen said that it does pose a risk and that FSOC is very focused on this issue because non-bank mortgage companies lack access to deposits which banks have. She added that non-banks also are reliant on short-term financing which is a lot less stable, and they tend to have very limited capital. She said that there is concern that in a time of stress we could see the failure of a non-bank mortgage company.
Warner talked about Artificial Intelligence and how FSOC has identified it as a threat to the financial market, he talked about how it can be used for market manipulation. He talked about a bill from him and Sen. Kennedy that would have FSOC play a coordinating role on AI and increase penalties for AI tools being used to violate existing securities laws. He asked if this is an area that Congress should move quickly to make sure that there is a comprehensive approach. Yellen said that she thinks that administration would welcome Congressional action in this area, and that FSOC identified AI as a vulnerability that could create systemic risk and they are monitoring the rapid developments to be able to define best practices for financial institutions.
State of the Economy and Economic Investments
Rounds asked Yellen if she believes the US is on a fiscally responsible path. Yellen said that we need to reduce deficits to stay on a fiscally sustainable path. She said that thus far, in real terms, the interest level of the debt has remained within or below historical norms, and the President’s budget last year suggested substantial deficit reduction that would hold interest expense at comfortable levels.
Sen. John Kennedy (R-La.) said he admires Yellen for being able to go out every day and defend Bidenomics which he likened to defending a fungal infection, and then asked Yellen if Bidenomics is just paying more to make life worse. Yellen disagreed with the characterization of Bidenomics and said that the U.S. had has done better than any other country in recovering from the pandemic and resuming growth. She noted that in the middle term Bidenomics focuses on helping the middle-class.
Kennedy then asked if the US will always face high prices. Yellen said that Bidenomics did not cause inflation and that due to the pandemic, some prices will always stay higher. She added that real wages have increased for American workers which translates to more disposable income.
Sen. Tina Smith (D-Minn.) asked Yellen if consumer spending is helping drive economic activity and growth. Yellen agreed. Smith and Sen. John Fetterman (D-Pa.) both asked Yellen if the US economy is the envy of the world, to which Yellen agreed.
Sen. Laphonza Butler (D-Calif.) and Sen. Bob Menendez (D-N.J.) asked Yellen to expand on how recent historic investments, such as the Inflation Reduction Act, have contributed to a stronger economy and stronger labor markets. Yellen said that one of the things that has been holding the US economy back was a failure to invest in infrastructure. She added that these bills are making sure that all parts of the country are benefiting, and specifically energy communities that have been dependent on coal.
Van Hollen asked Yellen for an update on the Biden Administration’s work on different outbound investment proposals. Yellen said that in response to the outbound investment Executive Order put forth by Biden in 2023, Treasury prepared a notice of proposed rulemaking that asked a series of questions and proposed information gathering and restrictions in the areas of artificial intelligence, semi-conductors, and quantum computing. She said that Treasury hopes to finalize the rulemaking after making changes based on comments received on the proposal.
Sen. Raphael Warnock (D-Ga.) asked Yellen to explain how state economies have improved in states that have expanded Medicaid. Yellen said that households in the states that did expand have more disposable income per average family.
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