In conjunction with the first edition of the Federal Reserve Board’s Supervision and Regulation Report, Randal Quarles, the Federal Reserve Board’s Vice Chairman for Supervision, testified at a hearing of the House of Representatives Financial Services Committee. Quarles concentrated on the Fed’s efforts to improve regulatory transparency, and its progress towards making the post-crisis regulatory framework simpler and more efficient.
The U.S. banking system is generally in strong condition, with both earnings and profitability increasing in recent years, according to the report. Loan volume is up, and nonperforming loan ratios are improving. Financial institutions also are maintaining high levels of quality capital and improving their liquidity due to new regulatory requirements.
On the other hand, the industry remains concentrated because of post-financial crisis consolidation.
Fed activities. The report says that, after the crisis, the Fed’s supervisory and regulatory framework has been based on three principles: efficiency, transparency, and simplicity. The goal is to minimize institutions’ compliance burden without compromising recent improvements in safety and soundness.
To accomplish this goal, the Fed has shifted some of its supervisory resources to its large bank supervision program, the report notes. The central bank also has enhanced its supervision of smaller banks based on the lessons taught by the financial crisis while reducing the banks’ regulatory burden.
This has been done by:
- reducing the amount of data these banks must submit each quarter;
- increasing the threshold for real estate loans that require formal appraisals;
- moving to simplify regulatory capital requirements; and
- reducing the burden of examinations, especially of on-site examinations.
The report found large financial institutions to be in sound financial condition. Capital levels are strong and much higher than before the financial crisis. Recent stress test results show that the capital levels of large firms after a hypothetical severe global recession would remain above regulatory minimums. While most firms have improved in key areas of supervisory focus, such as capital planning and liquidity management, it was noted that some firms continue to work to meet supervisory expectations in certain risk-management areas.
Future reports will focus on the Fed’s activities since each previous report, rather than looking back on the entire period since the financial crisis.
Quarles testimony. Under the Dodd-Frank Act, the Vice-Chairman is required to testify before the committee on a semiannual basis, regarding the Fed’s supervision and regulation of firms subject to the Fed’s jurisdiction.
Committee Chairman Jeb Hensarling (R-Texas) opened the hearing, entitled “Semi-Annual Testimony on the Federal Reserve’s Supervision and Regulation of the Financial System” by asserting that the Dodd-Frank Act "dramatically increased the Fed’s powers way beyond its traditional monetary policy responsibilities." According to Hensarling, with its heightened prudential standards, the Fed can "functionally now control the largest financial institutions in our economy."
Hensarling noted that while total overall regulatory restrictions have increased by nearly 20 percent since 1997, regulatory restrictions on "finance and insurance" have increased by 72 percent. He emphasized the work that the committee has devoted to properly tailoring financial regulation. "While I am pleased to see this Fed’s willingness to better tailor, perform cost-benefit analyses, implement prudential regulatory risk adjustments, and propose amendments to the Volcker Rule, each of these as they stand should again be viewed simply as first steps and insufficient to truly propel our economy to sustained 4 percent economic growth," concluded Hensarling.
Ranking Member Maxine Waters (D-Calif) also spoke at the hearing. Referencing the election results and the upcoming change in House leadership positions, Waters stated that she believes it is "appropriate to discuss Dodd-Frank and the harmful efforts of the current Committee Majority to weaken and roll back important parts of this law." She asserted that capital standards are an effective method to prevent bank failures and stated, "make no mistake, come January in this Committee, the days of this Committee weakening regulations and putting our economy once again at risk of another financial crisis will come to an end."
Transparency and efficiency. Quarles focused his testimony on steps the Fed has taken to increase transparency and keep the public and financial institutions informed. "Transparency is part of the foundation of public accountability and a cornerstone of due process" and "key to a well-functioning regulatory system and an essential aspect of safety and soundness, as well as financial stability," stated Quarles.
- The Fed has improved its supervisory ratings system for large financial institutions. The new rating system will better align ratings for these firms with the supervisory feedback they receive, and will focus firms on the capital, liquidity, and governance issues most likely to affect safety and soundness.
- The Fed has clarified that supervisory guidance is a tool to enhance the transparency of supervisory expectations, and should not be the basis of an enforcement action—guidance is not legally enforceable, and Fed examiners will not treat it that way.
- The Fed expects to finalize a set of measures intended to increase visibility into the Fed’s supervisory stress testing program. These enhanced disclosures will include more granular descriptions of our models; more information about the design of our scenarios; and more detail about projected outcomes.
Quarles discussed recent proposals issued by the Fed, including one that would reduce the reporting burden on community banking organizations, altering reporting frequencies, items, and thresholds, while preserving the data necessary for effective oversight. Another Fed proposal would reduce reporting requirements for small depository institutions in the first and third quarters of the year. Under the proposal, around 37 percent of data items would not be required in those quarters.
Quarles stated that the Fed has also issued two proposals to better align prudential standards with the risk profile of regulated institutions, implementing changes that Congress enacted this spring in the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). Additionally, according to Quarles, the Fed has recently proposed a new approach to calculating credit risk, and has issued a proposal simplifying and tailoring requirements under the Volcker rule. Quarles also stated that the Fed has issued a rule limiting the exposure of large firms to a single counterparty.
Quarles highlighted the agency’s efforts to tailor regulation and supervision to risk, including by:
- expanding eligibility of community banking firms for the Small Bank Holding Company Policy Statement, and for longer, 18-month examination cycles;
- giving bank holding companies below $100 billion in assets immediate relief from supervisory assessments, stress testing requirements, and some additional Dodd-Frank Act prudential measures; and
- implementing changes to liquidity regulation of municipal securities and capital regulation of high-volatility commercial real estate exposures.
