July 17, 2018

House Financial Services Committee Financial Institutions Subcommittee “Legislative Proposals to Increase Access to Capital”

Key Topics & Takeaways

  • Stress Tests and CCAR: A substantial amount of the hearing was spent discussing the various stress tests that banks are subjected to. Fromer, Baer, and Holtz-Eakin argued that the tests would benefit from transparency, with Baer noting that it is unusual for regulators to subject private institutions to regulatory examinations without public input on the examination itself. On CCAR specifically, Fromer argued throughout the hearing that the process is resource intensive for banks and is expensive to implement, and that an overall review of CCAR should look at its impact on capital distributions.
  • Asset Thresholds: Noreika used the hearing to call for the Federal Reserve to “immediately” lift prudential standards on banks with less than $250 billion in assets unless it can empirically demonstrate a need to apply higher requirements to an institution under that threshold. 

Witnesses

Opening Statements

Subcommittee Chairman Blaine Luetkemeyer (R-Mo.)

In his opening statement, Luetkemeyer argued that bank capital is important to protect consumers and the economy, but that regulators should be careful that capital requirements not harm economic growth or commercial choice. Luetkemeyer argued that the current capital regime is overly strict, and urged regulators to implement the statutory changes in S.2155, the Economic Growth, Regulatory Relief and Consumer Protection Act “right away.” 

Representative David Scott (D-Ga.)

In his opening statement, Scott argued that stress tests are an important tool for financial regulators but that they could be improved, and noted his support for H.R. 4293, the Stress Test Improvement Act of 2017. 

Testimony

The Honorable Kevin Fromer, President and CEO, Financial Services Forum

In his testimony, Fromer argued for a broad review of U.S. capital regulation, the capital planning process and leverage ratios. Fromer argued that the largest U.S. banks have significantly improved their capital and liquidity positions since the crisis, but that high capital standards reduces the availability of credit, so capital standards should be “appropriately calibrated.” Fromer praised the Treasury Department’s 2017 review of bank regulations and discussed the Federal Reserve’s proposed capital rules. Fromer called on the Federal Reserve to revise its proposed capital rules to allow boards of directors of global systemically important banks (G-SIBs) to make capital distribution decisions if they meet capital standards, improve the stress test scenarios, and conduct a cost-benefit analysis on the proposed stressed capital buffer. Regarding the enhanced supplementary leverage ratio (eSLR), Fromer called on regulators to exclude low-risk assets from the eSLR to encourage businesses to participate in low-risk business lines. Fromer noted that both the proposed stressed capital buffer and eSLR changes import the G-SIB surcharge, and argued the current G-SIB surcharge at present is too high and should be reconsidered by regulators.

The Honorable Greg Baer, President, Bank Policy Institute

In his testimony, Baer introduced the newly-formed Bank Policy Institute (BPI) and provided an overview of how BPI’s members have increased their Tier 1 common equity since the financial crisis, making them better capitalized. Baer also praised the results of BPI’s members through the latest round of CCAR. Baer also brought up the Current Expected Credit Loss (CECL) which becomes effective in 2020, and will potentially have a “profoundly” procyclical impact. Pivoting to the regulatory implementation of S.2155, Baer argued that institutions with under $100 billion in assets are fully exempted from enhanced prudential standards, while institutions with between $100 and $250 billion in assets are exempt from most standards in 18 months unless the Federal Reserve determines otherwise. Baer also expressed support for the stressed capital buffer and eSLR proposals from banking regulators. Baer called for the Federal Reserve to remedy “fundamental problems” with their stress tests, criticizing the “monomodal approach” to testing bank strength.  

Douglas Holtz-Eakin, President, American Action Forum

In his testimony, Holtz-Eakin praised S.2155, but argued there is “work left to do” to rationalize the financial regulatory regime. Holtz-Eakin urged policymakers to work on stress testing, which he argued is an “important tool…when done well” and called for transparency and multi-scenario tests. He also noted that stress test results are useful for creating market discipline on banks, as banks that struggle in their stress tests will have to answer to their investors. Holtz-Eakin also said that stress tests should not be conducted as part of a regulatory review of capital distributions.

Marcus Stanley, Policy Director, Americans for Financial Reform

In hist testimony, Stanley criticized “public guarantees” for financial institutions and the financial system, and said that because of these guarantees, financial institutions should be required to put substantial capital up to ensure they are able to cover losses. Stanley said that the largest banks can aggressively borrow up to 90 percent of their total asset value, a far higher level than non-financial institutions and non-bank financial institutions. Stanley criticized the arguments put forward to reduce capital standards, especially noting that economic growth has continued apace despite higher capital standards.

Keith Noreika, Partner, Simpson Thacher & Bartlett

In his testimony, Noreika noted that S.2155 directed the Federal Reserve to tailor its capital requirements to the “riskiness of an institution” instead of relying on raw asset size. Noreika argued that institutions less than $250 billion in assets are affirmatively exempted from enhanced prudential standards. Noreika also discussed the intermediate holding company (IHC) requirements and the regulatory requirements on foreign banking organizations (FBOs) which he argued caused a net increase in capital requirements. Noreika said that the IHC requirements could make international banks “less safe” because regulatory ring-fencing could prevent the bank from being able to move capital around. Noreika called for changes to the capital regimes for FBOs and said their regulatory requirements should be commensurate with their U.S. footprint.

Question & Answer

Stress Tests and CCAR

A substantial amount of the hearing was spent discussing the various stress tests that banks are subjected to. Fromer, Baer, and Holtz-Eakin argued that the tests would benefit from transparency, with Baer noting that it is unusual for regulators to subject private institutions to regulatory examinations without public input on the examination itself. These witnesses also argued for multi-scenario tests that probed bank strength in specific scenarios beyond the extremely adverse scenario currently used.  Baer specifically argued that regulators should average bank results over several different scenarios to determine if a bank passed or failed its stress tests. Holtz-Eakin also said that a more transparent process would create market discipline for banks to hold sufficient capital.

On CCAR specifically, Fromer argued throughout the hearing that the process is resource intensive for banks and is expensive to implement. He also criticized CCAR for making capital distributions difficult to plan, and that an overall review of CCAR should look at its impact on capital distributions. There was also criticism that CCAR caused credit allocation distortions, as the need to pass CCAR examinations pushes banks to expand and reduce certain business lines as a group, without regard to the economic impact of those kinds of decisions.

Asset Thresholds

Noreika used the hearing to call for the Federal Reserve to “immediately” lift prudential standards on banks with less than $250 billion in assets unless it can empirically demonstrate a need to apply higher requirements to an institution under that threshold. Noreika repeatedly noted that the $250 billion threshold is now only one part of a multipart determination of systemic risk, and that these institutions do not pose systemic risks. Baer said that BPI is concerned that regulators will use the examination process to impose regulatory requirements on banks with less than $250 billion in assets that S.2155 would otherwise prevent them from placing on them.

Capital Treatment of Mortgage Servicing Rights

Several members of the subcommittee asked witnesses if Basel III’s approach to capital requirements for mortgage servicing rights were harmful to the U.S. housing market. Baer described Basel as placing a “substantial penalty” on mortgage servicing rights and noted that mortgage servicing has migrated away from regulated banks to nonbank servicers as a result. Noreika also argued that these capital charges fell most heavily on community and regional banks and called on the Office of the Comptroller of the Currency (OCC) to finalize new mortgage servicing capital requirements.

Volcker Rule

During the hearing, Stanley argued against substantial changes to the Volcker Rule.

G-SIB Surcharge

Rep. Andy Barr (R-Ky.) asked if the G-SIB surcharge puts U.S. banks at a disadvantage compared to their international peers. Fromer argued that the higher surcharge in the U.S. limits capital available for operations and that regulators should revise the methods used to calculate the G-SIB surcharge.

Current Expected Credit Loss (CECL)

In response to a question from Luetkemeyer, Baer argued that a BPI analysis of CECL found that if CECL had been in place in 2007 it would have had a “profoundly procyclical” effect.

For more information on this hearing, please click here.