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House Financial Services Subcommittee Hearing

September 30, 2024 Uncategorized

HOUSE FINANCIAL SERVICES SUBCOMMITTEE HEARING

OVERVIEW

For questions on the note below, please contact Edmund Perry at (202) 547-3035 or Ruth Lunsford at (434) 238-7224.  

On September 25, the House Committee on Financial Services Subcommittee on Financial Institutions and Monetary Policy held a hearing entitled “Regulatory Recipe for Economic Uncertainty: The Endless Basel Endgame and an Onslaught of Hurried Rule-making Undertaken by the Administration.”  Witnesses in the hearing were: 

Below is a summary of the hearing prepared by Delta Strategy Group.  It includes several high-level takeaways from both panels, followed by summaries of opening statements and witness testimonies and a summary of the Q&A portion of the hearing. 

KEY TAKEAWAYS 

The following is a summary of the main topics explored in today’s hearing.  Each is discussed in further detail in the discussion section below.  

  • In the hearing, there was bipartisan concern about whether the proposed regulatory changes would contribute or detract from American competitiveness.  Democrats, like Ranking Member Maxine Waters (D-CA-43), contended that delays and blocks to rule-making undermine necessary regulations regardless of partisan shifts dictating regulatory agendas.   
  • Republicans, such as Representative Barry Loudermilk (R-GA-11) and Representative Andy Barr (R-KY-06), caution that the proposed rule could introduce significant uncertainty into the financial system, potentially harming American competitiveness.  Republicans argued that increased compliance costs may limit banks’ ability to lend, thereby impacting consumers who are already struggling to afford basic services.  
  • Democrats emphasized the need for strong capital regulations to prevent future bailouts that tear the social contract and ensure financial stability. Representative Sherman (D-CA-32) warned that inadequate capital levels could jeopardize the economy and disproportionately harm underserved communities seeking credit.  

SUMMARY

Opening Statements and Testimony 

Subcommittee Chairman Andy Barr (R-KY-06) 

While bipartisan oversight has been commendable, the initial July 2023 proposal faced widespread criticism, with 97 percent of comments negative and 86 percent from non-bank stakeholders.  Despite being framed as a response to recent bank failures and interest rate risks, much of the proposal is unrelated to those issues.  There are concerns with the proposal’s effects on mortgage markets, tax credits, and various financial products, raising alarms about its detrimental impact on home buyers, farmers, smaller institutions, and consumers.  Recent remarks by Vice Chair Michael Barr suggest forthcoming changes to the July proposal, which may have support within the Federal Reserve (Fed), but details are scarce, and a vote has yet to occur.  There is a troubling trend among Democrat-appointed regulators to forgo basic cost-benefit analyses, raising concerns about unintended consequences for constituents.  The Subcommittee’s ongoing work is crucial to ensure that regulators operate within their statutory authority and adhere to laws passed by Congress.  Clear, stable regulatory practices are essential for the effective functioning of credit and capital markets in the interest of investors and consumers. 

Subcommittee Ranking Member Bill Foster (D-IL-11)  

Since the publication of the Basel III proposal, our Committee has engaged with numerous experts on the appropriate capital levels for systemically important banks.  The Basel III recommendations were finalized by the Trump administration in 2017, aiming to standardize capital requirements and enhance competitiveness for US banks internationally.  On September 10, Fed Vice Chair Michael Barr indicated intentions to partially revise the Basel III capital rules, addressing committee concerns about areas such as residential mortgages and renewable energy investments. Barr’s recommendation suggests a 9 percent increase in capital requirements for the largest banks, a reduction from an initial 18 percent.  This hearing is premature as the detailed re-proposal remains unavailable to the Committee and public, leading to continued uncertainty and lack of clarity about how the specifics of these changes will be implemented.  

Jonathan V. Gould, Partner, Jones Day 

The Basel III endgame proposal has faced significant criticism for its lack of substantive data and rigorous analysis, which hinders banks’ ability to make informed decisions and ultimately affects economic activity.  While the agencies have made attempts to address these concerns, such as data collection efforts, these responses seem reactionary and insufficient.  This initiative is not driven by a Congressional mandate.  Vice Chair Barr’s review indicated the existing framework is sound, yet it led to broad changes without transparent analysis, raising concerns about its credibility.  The specifics of which operational areas will be affected remain unclear, underscoring the need for timely implementation of appropriate safeguards to ensure U.S. economic strength and financial stability.  There are concerns that the EU may delay key Basel III reforms due to inaction in the U.S., highlighting the need for coordination among the Fed, Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) moving forward. I recommend that Congress provide clearer guidance on regulatory capital matters as the current approach lacks accountability and risks significant economic implications.  As this Committee has demonstrated with this rule-making, Congressional engagement can improve agency process and substance, and I encourage this Committee’s continued and indispensable oversight. 

Kenneth E. Bentsen, Jr., President and Chief Executive Officer, SIFMA 

It is essential for policymakers, including Congress, to conduct thorough analysis and oversight to balance financial stability with macroeconomic growth.  Since the financial crisis, high-quality capital in the U.S. banking system has tripled, loss-absorbing capacity has increased six-fold, and liquidity levels have risen twelve-fold.  Independent studies suggest that capital levels at major U.S. banks are at or near optimal levels, and senior officials, including Treasury Secretary Yellen and Fed Chair Powell, have affirmed that the banking system is strong and well-capitalized.  Diverging from other jurisdictions in implementing Basel III undermines one of the key goals of the Basel agreement: to promote greater cross-border harmonization and comparability in capital requirements. Given robust capital reserves, any proposed increases should be critically evaluated for their tangible benefits and potential economic costs, ensuring that large banking organizations can effectively serve as intermediaries in capital markets, which support about three-quarters of U.S. economic activity.  These rulemakings are incredibly important to our economy, and therefore it is crucial that policymakers get them right. 

Marc Jarsulic, Chief Economist, Center for American Progress 

I want to emphasize the importance of adequate bank equity levels for financial stability and economic performance, alongside the necessity for strong capital regulation.  Regulatory capital rules are vital as they help banks ensure against asset losses, ensuring solvency and preventing runs on banks.  Increased bank equity enhances overall economic performance and reduces the likelihood of negative GDP growth without impacting expected growth.  The proposed rules represent a significant advancement by requiring banks with assets over $100 billion to include unrealized gains and losses on securities when calculating capital ratios.  This adjustment prevents the misclassification of securities to avoid recognizing losses, a critical step given that banks had unrealized losses of approximately $620 billion in 2022.   

However, the proposed capital requirements do not sufficiently raise minimum bank equity.  A 9 percent increase in risk-weighted capital falls short compared to observed loss rates from previous crises.  Regulators must take decisive action to reduce leverage.  While equity ratios for large banks rose after the 2008 crisis, they have since declined to around 6 percent, indicating that these banks are less prepared for economic shocks.  Reversing this trend is essential for enhancing financial stability and supporting credit creation.

DISCUSSION 

Barr (R-KY-06):  How would the Basel III endgame increase costs for hedging interest rate risk?  Bentsen: The proposal inconsistently treats cleared and uncleared derivatives, effectively imposing a capital tax on certain hedging activities. 

Foster (D-IL-11): How capable are members of Congress in evaluating complex regulatory issues compared to regulators?  What does research suggest about capital requirements for large banks?  Bentsen: A higher percentage of members likely understand these issues.  Congress has historically been involved in regulatory processes due to their economic impact;  Jarsulic: Studies indicate that higher equity-to-risk-weighted asset ratios can reduce financial crisis likelihood, benefiting the economy by enhancing credit availability. 

Williams (R-TX-25): Should regulators delay implementation of the long-term debt rule until Basel III is finalized?  How will Basel III impact bank lending and costs for borrowers?  Bentsen: Yes, the long-term debt proposal interrelates with Basel III, and its implementation should be postponed;  Gould: Anticipated capital increases may lead banks to conserve capital, affecting lending and potentially raising costs or limiting options for borrowers. 

Waters (D-CA-43): What lessons should we learn about deregulation and its impact on recent bank failures and the 2008 crisis?  Could capital requirements limit lending for well-capitalized banks?  Jarsulic: Regulations must ensure banks have adequate self-insurance to withstand economic shocks.  Weak equity standards can threaten financial stability and economic growth.  Capital requirements ensure banks finance their activities proportionally; higher equity levels actually enhance credit creation. 

Rose (D-NY-15): Who approves the Basel III endgame if Congress isn’t involved?  Gould:  It involves agency principals and their advising staff.  Rose: Should we proceed with a proposal that could harm our competitiveness? Gould:  I do not believe it is in our best interest to proceed with this proposal. It is possible to implement without increasing capital, but it depends on the agencies to determine how.  

Loudermilk (R-GA-11): Does negative public sentiment indicate broad opposition to the proposal?  Is it inaccurate for the media to say Barr’s speech softens rules for financial institutions?  Gould: Yes, unusual public comments suggest a lack of broad support.  The characterization is one-sided; it also concerns end– users dependent on banks.  Some concerns seem to be acknowledged by Vice Chairman Barr’s speech, but many questions remain, particularly regarding the proposed 9 percent capital increase. 

Fitzgerald (R-WI-05): Should regulators avoid moving forward with other proposals until key changes are made to Basel?  Gould: Yes, agencies must finalize Basel III first;  Bentsen: I agree, the proposal overlooks the diverse business models of banks.  

Timmons (R-SC-04): Is increasing politicization damaging to banking regulation?  Gould: Yes, it erodes agency credibility and complicates rule consistency over time.   

De La Cruz (R-TX-15): Have you seen analyses of regulatory proposals’ combined effects?  Gould: No detailed analysis exists, and we expected more from the capital review; Bentsen: The industry did an analysis that regulators should have conducted earlier to understand market impacts.