Fed Undertakes Implementation of S. 2155 (November 16)

Update 313 — Quarles Tailoring Too Swiftly?
Fed Undertakes Implementation of S. 2155

The current Congressional interregnum known as the Lame Duck session affords a chance to consider how the Fed plans to implement S. 2155, the broadest rollback of Dodd-Frank to date.  So far, evidence suggests that the implementation process be watched closely.

It invokes serious issues ranging from the limits of regulatory discretion to systemic risk policy on the merits.  We commend, as a sensible alternative to the proposal Fed Governor Quarles is concocting, the perspective of Governor Lael Brainard.  See below.

Good weekends all,




Yesterday, Michelle “Miki” Bowman was confirmed as Fed Governor by the Senate on a 64 to 34 vote. She adds another deregulation supporter to the Fed Board.

This week, the Fed’s Vice Chairman Randal Quarles testified in front of the House Financial Services and Senate Banking Committees to give an overview of the supervision and regulation of the financial system. His testimonies come after a speech last Friday at Brookings, where he detailed a list of changes to the current stress testing regime. It also comes in the wake of a Fed proposal last month to ease regulation for banks under $700 billion in assets.  

Will Fed Eviscerate Stress Tests?

On November 9, Randal Quarles gave a speech at Brookings detailing plans to overhaul the Dodd-Frank stress testing framework for the largest financial institutions. In the name of efficiency, “recalibration,” and “tailoring,” the Fed is proposing to reduce standards that were designed to ensure the resiliency of banks to weather any crises and are the basis for capital requirements.

The changes under consideration by the Fed are:

  • exempting banks with assets less than $250 billion from CCAR quantitative assessment and supervisory testing in 2019

  • disclosing stress test outcomes to firms before they execute their capital distributions

  • exempting leverage ratio requirements from future stress testing models

  • decreasing capital buffers for most banks by 2020 at the earliest

Capital and Liquidity Rules in Fed’s Sights

Late last month, the Federal Reserve Board voted 3-to-1 to reduce oversight and capital requirements for the 16 largest regional banks in the country. The Fed “tailoring” (deregulating by another name) implementation is now in full force.

The Fed’s proposal would create four new categories for how bank holding and savings and loan companies are treated:

  • Category I: Global Systemically Important Banks (GSIBs)

  • Category II: Banks with more than $700 billion in assets or $75 billion or more in cross-jurisdictional activity

  • Category III: Banks with between $250 billion and $750 billion in assets

  • Category IV: Banks with between $100 and $250 billion in assets

The proposal would be a huge let-off for banks in the $100 to $250 billion asset range, such as BB&T and Suntrust. These banks will be exempted from the liquidity coverage ratio, substantially reducing their requirement to be able to turn assets into cash in the event of a crisis. Fed Governor Lael Brainard estimates that these changes would reduce high quality liquid assets by around $70 billion and reduce their liquidity buffers by around 15 percent.

The changes also reduce oversight by eliminating the annual stress test requirement for these institutions, moving it to a bi-annual basis. Large “mega-regional” banks with assets between $250 and $700 billion such as US Bancorp, Capital One, and PNC Financial would also face much lighter liquidity requirements, equivalent to 70 to 85 percent percent of their current liquidity coverage ratio.

Signed into law in May, S. 2155 was touted as a regulatory relief bill for smaller banks and credit unions ostensibly stifled by excessive regulation, but the Fed’s new rule loosens restriction for mega-regional banks between $250-700 billion in assets. These mega-regionals are as or more likely to be both culprit and victim in a meltdown as any firms in other financial subsectors, given their increasing interconnectedness with each other, as well as with their Wall Street counterparts.

Per Sen. Brown: The “Fed’s proposed rule loosens protections for banks with more than $250 billion in assets – not small community banks – we’re talking about the nation’s biggest financial institutions.”  Ten years after the financial crisis, the nation’s most important regulators are eroding the fundamental protections offered under Dodd-Frank, increasing systemic risk, and leaving taxpayers at risk of a future bailout.

Consternation in Congress

On November 14, Democrats on the House Financial Services Committee (HFSC) raised their concerns with the Fed’s new proposals. Rep. Maloney questioned the provision to reduce the liquidity requirement for banks in the new Category III tier. Quarles argued that the language of S. 2155 now requires the Board to tailor policies to institutions between $100 and $250 billion in assets, but did not fully justify the decision to lower liquidity standards for such large banks. Moreover, the statement was inconsistent with his remarks against supervisory complacency in boom times.

The next day, Quarles recanted this testimony before the Senate Banking Committee. Sen. Brown highlighted his concern over the proposed reduction in capital requirements and argued that the proposed stress test “transparency” measures were akin to giving “students the answers to a quiz ahead of time.” Sen. Warren questioned the reduced enforcement of leverage lending ratio guidelines, forcing Quarles to admit that they would not hold banks to the standards set by the Fed, OCC, and FDIC in 2013.

Tailoring Too Swiftly?

In recent months, the Fed has proposed other significant rule changes, like adjusting the the enhanced supplementary leverage ratio (eSLR) — a change predicted to reduce GSIB capital requirements by $121 billion. The Fed is also on the verge of proposing changes to living wills requirements, releasing banks in the $100 to $250 billion asset range from filing resolution plans, thereby increasing systemic risk.

A Toxic Brew of Deregulation

The Fed is pushing ahead with rulemaking that threatens to increase systemic risk and harm the stability of the financial system. Fed Governor Lael Brainard explains, “I see little benefit to the institutions or the system from the proposed reduction in core resilience that could justify the increased risk to financial stability and the taxpayer.”

This deregulatory agenda will soon have a powerful challenger in Congress. The likely next HFSC Chair, Maxine Waters, told the public during the Nov. 14th hearing: “Make no mistake, come January, the days of this committee weakening regulations and putting our economy once again at risk of another financial crisis will come to an end.”

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