What would the regulators do?

In recent weeks, we have had Congress promote deregulation with a Dodd-Frank rollback called the Financial Choice.

President Trump has also taken up that cause, and the Treasury Department just released a 600-page report that is merely the first volume in its deregulatory blueprint.

Regulators, at least those who started work during a Democratic administration, may be leery of a regulatory Ragnarök, but nevertheless have their own ideas on reforms. Several of them offered these suggestions during a June 22 hearing before the Senate Banking Committee on “Fostering Economic Growth.”

Among those weighing in was Martin Gruenberg, chairman of the Federal Deposit Insurance Corporation. In his view, the post-recession regulatory regime, although not perfect, has been effective.

The quarterly number of problem institutions rose from fewer than 50 in 2006 to a peak of 888 in 2011. In all, 520 FDIC-insured institutions failed between 2008 and 2016. The balance of the FDIC’s Deposit Insurance Fund fell to a low of nearly $21 billion in the red at the end of 2009.

The economic expansion that began in 2009 is now approaching its ninth year. While critics may complain about its speed, there have been results. FDIC-insured institutions have made “substantial progress in strengthening their capital and asset quality, and in raising their net income to record highs,” Gruenberg said.

The industry’s equity capital-to-assets ratio had never exceeded 11 percent prior to the second quarter of 2010, he added. Since mid-2010, it has never failed to exceed 11 percent. The annual number of failed institutions fell to single digits in both 2015 and 2016, and the number of problem banks fell to a nine-year low of 112 as of March 2017.

“The state of the community banking sector is of particular importance because of the outsize influence these institutions have on their local economies,” Gruenberg said, establishing his take on regulatory reform.

 “It is desirable that financial regulations be simple and straightforward, and that regulatory burdens and costs be minimized, particularly for smaller institutions,” he added.

The Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) requires the federal banking agencies—the Office of the Comptroller of the Currency, the Federal Reserve Board, and the FDIC—along with the Federal Financial Institutions Examination Council, to conduct a review of our rules at least every ten years to identify outdated or unnecessary regulations.

The review has now turned to regulations contained in the Dodd-Frank Act and the recently promulgated domestic capital and liquidity rules. Among the findings in a report issued to Congress in March: the complexity of the risk-based capital rules was cited as a challenge for community bankers.

Among the comments received on the report were demands that supervisory expectations intended for large banks not be applied to community banks.

The agencies have taken, or are in the process of taking, actions to address comments received during the EGRPRA process, Gruenberg said.

They include: developing a proposal to simplify the generally applicable capital framework; simplifying the current regulatory capital treatment for mortgage servicing assets; and simplifying the current limitations on minority interests in regulatory capital.

Banking regulators have also worked together on a multi-phase plan to both simplify and reduce regulatory reporting requirements.

“To support the economic growth fueled by small business and agriculture, it must be a priority to reverse the hollowing out of community banking.”
Charles Cooper, Banking Commissioner, Texas Department of Banking

Community bankers have raised concerns that the thresholds for requiring appraisals pursuant to the banking agencies’ regulations have not been changed in a number of years. Regulators, in response, are developing a proposal to increase the threshold for requiring an appraisal on commercial real estate loans from $250,000 to $400,000, “which we believe will reduce regulatory burden in a manner consistent with safety and soundness,” Gruenberg said.

The agencies are jointly reviewing the examination process, report format, and examination report preparation process “to identify further opportunities to minimize burden to bank management where possible,” he added. The agencies also plan to review interagency guidance, such as policy statements, to update and streamline guidance.”

Streamlining living will requirements was cited as another priority and agencies are exploring to improve the resolution planning process. Under consideration is extending the cycle for living will submissions from annual to once every two years.

Some EGRPRA commenters suggested raising the $10 billion in total assets threshold for conducting annual stress tests set forth in the Dodd-Frank Act. Gruenberg said the FDIC, in large part, agrees with these commenters, and supports legislative efforts to increase the threshold from $10 billion to $50 billion.

In addition to this recommendation, the FDIC would be receptive to legislation further increasing the asset threshold for banks eligible for an 18-month examination cycle from $1 billion in total assets to $2 billion in total assets. This would allow about another 340 institutions to potentially qualify for extended examination cycles. These institutions also would be eligible for extended Bank Secrecy Act and anti-money laundering reviews.

Keith Noreika was selected by President Trump to be Acting Comptroller of the Currency. His regulatory views fall in line with those of the administration.

“Our job as bank supervisors is to strike the right balance between supervision that effectively ensures safety, soundness, and compliance, while, at the same time, enabling economic growth,” he said. “To achieve that balance, we need to avoid imposing unnecessary burden and creating an environment so adverse to risk that banks are inhibited from lending and investing in the businesses and communities they serve.”

“Regulation does not work when it impedes progress, and banks cannot fulfill their public purpose if they cannot support and invest in their customers and communities,” he added.

The OCC, Noreika said, has met with various trade groups, scholars, and community groups “to begin a constructive, bipartisan dialogue on how our regulatory system might be recalibrated to foster economic growth.”

Included in those discussions: simplifying the regulatory framework implementing the Volcker rule.

“In recent years, many of the nation’s financial institutions have struggled to understand and comply with these regulations, devoting significant resources that could have been put to more productive uses,” Noreika said. “The Volcker Rule provides a practical example of how conflicting messages and inconsistent interpretation can exacerbate regulatory burden by making industry compliance harder and more resource intensive than necessary.”

Noreika is also soliciting ideas for curbing duplicative regulations and regulator overlap.

One suggestion: Congress could reduce regulatory redundancy in this situation by amending the Bank Holding Company Act to provide that when a depository institution constitutes a substantial portion of its holding company’s assets (for example, 90 percent), the regulator of the depository institution would have sole examination and enforcement authority for both the holding company and the depository institution.

ROOM FOR COMPROMISE?

The following were opening comments at “Fostering Economic Growth: Regulator Perspective,” a June 22 hearing of the Senate Banking Committee.
U.S. Senator Mike Crapo (R-Idaho), chairman of the Senate Committee on Banking, Housing and Urban Affair:
Based on conversations I have had with current and former regulators, recommendations in Treasury’s recent report, testimony at hearings before this Committee, and the recent EGRPRA report, I am convinced that there is growing support for legislation that promotes economic growth.
I have had conversations with members on both sides of the aisle who have told me that they are committed to pursuing bipartisan improvements.
One of my key priorities this Congress is passing bipartisan legislation to improve the bank regulatory framework and promote economic growth.
In March, Ranking Member Brown and I began our process to receive and consider proposals to help foster economic growth, and I appreciate the valuable insights and recommendations we have received
Most recently, we heard from small financial institutions and from midsize and regional banks about the need to tailor existing regulations and laws to ensure that they are proportional and appropriate.
For example, something that witnesses highlighted that has bipartisan agreement is that the regulatory regime for small lenders is unnecessarily burdensome.
There also seems to be genuine interest by members in assessing whether certain rules applied based on asset threshold alone reflect the underlying systemic risk of financial institutions.
Specifically, there is interest in finding bipartisan solutions aimed at: tailoring regulation based on the complexity of banking organizations; changing the $50 billion threshold for SIFIs; exempting more banks from stress testing; simplifying the Volcker Rule; and simplifying small bank capital rules.
U.S. Sen. Sherrod Brown (D-Ohio), ranking member of the Senate Committee on Banking, Housing, and Urban Affairs:
None of our witnesses probably had their homes foreclosed upon, lost their jobs because their company went out of business, or watched lifelong retirement savings disappear.
But maybe they know someone, a friend or family member, who did.
That is what Wall Street greed and the resulting financial crisis did to millions of Ohioans and so many of our constituents. These are the people we work for, that you work for. And we must never forget their stories.
Wall Street Reform created a more stable financial sector by strengthening the capital positions of the nation’s largest banks.
American consumers have recovered $12 billion of their hard-earned money because we now have an independent agency—the Consumer Financial Protection Bureau—protecting them from scams and abuse.
That’s why the report that the Treasury Department released last week is so misguided.
The report is a Wall Street wish list, specifically targeting the capital and liquidity rules for the largest banks and seeking to undermine the CFPB.
The report takes as gospel that more lending and leverage is the best way to create economic growth.
Data shows that lending has been healthy and at sustainable levels since the crisis. The last thing we should advocate for is going back to the levels 2001, 2002, and 2003, which led to the subprime crisis—a time period that the Treasury report holds up as an example.
And there is no evidence that relaxing rules will lead banks to lend more. It is just as likely that bank executives will pass any savings along to themselves and to their shareholders.
I am also concerned that many of Treasury’s recommendations will undermine or delay the effectiveness of bank supervision, something that was severely lacking leading up to the crisis.
These misguided ideas include additional layers of cost-benefit analysis, more obstacles to supervisory actions, weakened leverage rules, changes to stress tests that would allow banks to game the test, and changes to living wills, to name a few. These recommendations would make the watchdogs’ jobs harder, and prevent them from spotting risks before they balloon out of control. They would make our system less stable and leave consumers more vulnerable.
Treasury’s report missed an opportunity to put forth an agenda that creates real economic growth for Americans.
In fact, at every turn, the Administration has advocated for an agenda that hurts average Americans—handouts for Wall Street, tax cuts for millionaires and billionaires, less health care for working people, and cuts to programs that help those who need it the most.
There are some ideas worth considering in the Treasury report, as evidenced by overlap with some of the recommendations in the Agencies’ EGRPRA review for small institutions, but many of Treasury’s recommendations seem like a steep price for Americans to pay after the 2008 financial crisis.
We have seen the damage that can happen when an Administration pushes financial watchdogs to prioritize special interests over working people.
It is pretty telling that Treasury met with 17 industry representatives for every one advocate for ordinary Americans, and that 31 out of 40 requests made by those representing the biggest banks were included in the report.
I hope this committee can focus on the issues that will reduce burdens for small institutions in struggling communities, help consumers, and create long-term, sustainable economic growth.

“This change would eliminate supervisory duplication and its inherent inefficiencies, freeing resources to meet the needs of banks’ customers and communities. It could be limited to BHCs of a certain asset size,” Noreika said. “At the same time, banking law would continue to recognize that it is appropriate to have a separate regulator for large companies that conduct complex activities, including securities and derivatives businesses, as well as consumer and commercial banking.”

Noreika said his approach “is akin to a system of traffic lights.”

“One regulator has the lead responsibility or primary authority: it has a ‘green light to act,” he said. “Other regulators that have concurrent or back-up authority have a ‘red light.’ They wait to act until a contingency provided in the law has occurred.”

Noreika said that exempting community banks from the Volcker rule (or at least providing an “off-ramp) and international Basel-based capital standards must also be considered.

“To support the economic growth fueled by small business and agriculture, it must be a priority to reverse the hollowing out of community banking,” said Charles Cooper, banking commissioner of the Texas Department of Banking, speaking on behalf of the Conference of State Bank Supervisors.

Among his suggestions are ensuring that state regulators and local communities are represented in the national policy development process.

He also decried the “effect of unwieldy application of federal rules” as illustrated by the impact that international Basel III standards have had on community banks.

The current capital standards, promulgated by the Basel Committee on Banking Supervision regarding risk-based capital, leverage, and liquidity were designed for internationally active, complex organizations. Federal prudential regulators have implemented Basel standards through formal rulemaking, and community banking organizations became subject to the final Basel III rule in 2015.

“Although the final rule included key changes that federal regulators designed to provide relief to community institutions, the current capital regime introduces unnecessary reporting complexity and costs, which impact community banks’ ability to participate in certain activities,” Cooper said.

He agrees with a recommendation found in the Treasury Department report that a simplification of the overall capital regime for community banks is necessary, “as the complex U.S. capital rules implementing Basel III standards are not appropriately tailored.”

Although various regulators agreed that regulatory reduction and tailoring was a worthy goal, there were some concerns. Gruenberg, for example, reminded the committee that while $50 billion in assets might not make an institution “systemic,” that was no guarantee of complete safety. A $30 billion thrift institution, IndyMac, ultimately cost the deposit insurance fund more than $12 billion dollars.

“I would be wary of prescriptive things, like limiting dividends and that sort of thing,” said Federal Reserve Governor Jerome Powell. “I don’t think what we are talking about here amounts to broad deregulation. It is making regulation more efficient while protecting the important gains we have made.”