Certificate from the Deputy Head of the Supervision Department for supervision and organization

Certificate from the Deputy Head of the Supervision Department for supervision and organization

We thank you Chairman Brown, Ranking Member Scott, and other Committee members for the opportunity to testify about the Federal Reserve’s supervisory and regulatory activities. My certificates accompany the Federal Reserve’s semiannual report Supervision and organization report. Today I will discuss current conditions in the banking sector, supervision, and some of our recent regulatory proposals.

Banking terms
Our banking system is sound and resilient. The acute pressures experienced in March have subsided, and banking institutions continue to report capital and liquidity ratios above minimum regulatory levels. Earnings performance remained strong and in line with pre-pandemic levels, despite recent pressures on net interest margins.

Regulatory capital ratios rose during the first half of 2023. While liquidity levels have declined from their peak in 2021, they remain above pre-pandemic levels, and above minimum regulatory levels, as applicable, leaving the banking system well positioned to mitigate Liquidity pressures. that may arise.

The failures of Silicon Valley Bank, Signature Bank, and First Republic Bank reflected, to varying degrees, excessive interest rate risks in their long-term assets and over-reliance on uninsured deposits. While the three bankrupt banks were extreme cases, there are others that invested heavily in fixed-interest and long-term assets when long-term interest rates were low. These banks have recorded significant declines in the fair value of those assets as interest rates have risen, resulting in pressure on tangible capital. Banks are managing the resulting set of risks effectively, but addressing them may take some time. In addition, some banks that rely heavily on uninsured deposits use more expensive sources of funding to manage their liquidity risks.

Lending has continued to grow this year, albeit at a slower pace than in 2022, due in large part to lower demand for loans and tightening lending standards, according to respondents in recent Federal Reserve senior loan officer surveys. Loan delinquency rates remain generally low, and banks have increased provisions for credit losses to mitigate potential future losses in response to increased delinquencies on loans related to commercial real estate and some consumer sectors.

Looking to the future, maintaining a sound and resilient banking system requires continued attention to address identified weaknesses and vigilance to changing conditions.

Supervisor
Starting with supervision, since the bank failures earlier this year, the Fed has been moving forward with finding ways to improve the speed, strength, and flexibility of supervision as appropriate. Supervision must be intensified at the right pace, especially as a company grows in size or complexity, and critical issues that pose safety and soundness concerns must be addressed quickly by banks and supervisors. When considering improvements to supervision, we are keenly aware of the differences in size, risk and complexity of supervised institutions and the importance of maintaining the strength and diversity of banks of all sizes that serve communities across the country.

Furthermore, regulators have focused on addressing the material risks presented by the current economic environment as well as the rapid pace of innovation. This includes conducting targeted reviews at banks that exhibit higher interest rate and liquidity risks and conducting focused training and awareness raising on supervisory expectations around these risks. The Fed is also monitoring potential credit deterioration, especially within the consumer lending and CRE sectors. In addition, the Federal Reserve implemented a new banking supervision program to improve oversight of banks involved in non-traditional financial activities associated with fintech.

However, neither banks nor regulators can anticipate all emerging risks. For this reason, it is also important to help ensure that our regulatory framework sets a strong baseline for resilience, regardless of how or where risks arise.

capital
The key element of this flexibility is capital. Banks rely on both debt (such as deposits) and capital to finance loans and other assets. Capital allows banks to absorb losses on those assets while continuing to serve households and businesses. In addition, capital absorbs loss regardless of the source of the loss. This means that whatever the vulnerability or shock, capital is able to absorb the resulting losses and, if sufficient, allows banks to continue to play their crucial role in the economy.

In the global financial crisis, the effects of woefully undercapitalized banks had a devastating impact on our economy and led to the worst recession since the Great Depression. It took six years for employment to recover, more than 10 million people fell into poverty, and 6 million families lost their homes to foreclosure. These costs occurred even with significant government support.

In the years following the global financial crisis, the Federal Reserve Board (the Board) adopted a range of reforms to increase the quantity and quality of capital, conducted annual supervisory stress tests, and imposed capital surcharges on global systemically important banks (G-SIBs). ) to reflect the greater risk these companies pose to financial stability in the United States. These reforms have greatly strengthened our banking system, and the capital ratios of the largest banks have doubled since 2009. At the same time, the US banking system has grown from $12 trillion in assets in 2009 to $23 trillion today, while showing Strong profitability. And overall market value. American banks have strengthened their position as leaders in global capital markets activity. More importantly, these reforms served the American economy well. Our economy has grown significantly thanks to the continued support of strong lending from a stronger banking system.

The capital requirements framework reforms we proposed earlier this year are the final stage of post-crisis capital reforms. It has long been recognized that work remains to improve how banks measure risk, which is crucial because the riskier a bank’s assets are, the more capital it needs to protect against those risks. To address these and other issues, the Board, along with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), proposed a rule in July that would reduce the likelihood of future financial crises. The proposed rules would apply to banks with assets of at least $100 billion, that is, fewer than 40 banks out of more than 4,000 banks in our banking system. Community banks will not be affected by this proposal.

First, for a company’s lending activities, the proposed rules would end the practice of relying on each bank’s internal estimates of its credit risk, and use a uniform risk-based measure of credit risk. Standardized credit risk approaches are designed to approximate the risks observed over economic cycles, which internal models tend to underestimate. This approach also ensures consistency across banks to avoid material variation identified in internal models across institutions. Volatility reduces transparency and comparability and leads to the same loan being treated differently between banks. The proposed standardized approach to credit risk is broadly consistent with the standardized approach that banking bodies have used for decades, but is more risk sensitive.

Second, for operational losses—losses resulting from inadequate or failed processes, such as fraud, illegal behavior, or cyberattacks—the proposed rules would replace the use of banks’ internal models to measure operational risk with a uniform metric.

Third, for a company’s trading activities, where typical methods are more reliable, the proposed rules require more detailed methods for measuring market risk, namely the risk of loss resulting from market price movements, to correct loopholes in the existing rules and improve them. Capture risks. For example, the current market risk framework could increase capital requirements during stresses rather than requiring a larger amount of capital before the stresses occur.

Fourth, the proposal improves capital requirements for credit risks associated with derivatives activities by introducing uniform risk-sensitive measures.

Most aspects of this proposal have been in development for many years. Partly in response to pressure from banks this spring, the proposal would expand the requirement to include unrealized gains and losses on available-for-sale securities in capital ratios beyond the largest, most complex banks to all large banks with assets exceeding $100 billion. .

The proposed rules are expected to increase capital requirements for large banks, but the impacts for each bank will differ based on its activities and risk profile. It is worth noting that the increases will be very large for the largest and most complex banks, with the bulk of the estimated increase attributable to trading and other non-lending activities.

The comment period is an important part of the rulemaking process. I want to reiterate that we are interested in public input. We recently announced an extension of the comment period. With this extension, we give the public approximately six months to review the proposal, so they can provide meaningful feedback. We have already heard concerns that the proposed risk-based capital treatment for mortgage lending, tax credit investments, business activities, and operational risks may overstate the risks of these activities. We welcome all comments that provide agencies with additional data and perspectives to help ensure that the rules accurately reflect risks.

Long term debt
I would also like to highlight our proposal on long-term debt. In October of last year, the agencies issued an advance notice of proposed rulemaking seeking comments on potentially extending long-term debt requirements to more banking institutions beyond the largest and most complex. The bankruptcies of three large banks in the spring led to losses in the Deposit Insurance Fund and financial stability concerns that could have been partly mitigated by additional long-term debt requirements.

Following those events, in August, the agencies proposed a rule that would expand long-term debt planning and resolution requirements to include additional large banks. The goal of the proposal is to increase potential options available to dissolve depository institutions and promote overall financial stability. Importantly, the proposed requirements will be calibrated at a lower level compared to the largest and most complex banks, in recognition of the lower systemic risks of the banks involved. In addition, since these banks already issue some long-term debt and the proposal provides for a long phase-in period, banks would generally only need to issue debt gradually to meet the proposed requirements.

As with the capital rules I mentioned above, I would like to stress that these are proposed rules, and we look forward to hearing public feedback.

Community Reinvestment Act
As for other material rules, the agencies recently finalized a rule that strengthens and updates the regulations implementing the Community Reinvestment Act (CRA). The revised rule would better encourage banks to help meet the credit needs of their entire communities, including low- and moderate-income neighborhoods.

The final rule is the result of many years of public engagement and several rounds of rulemaking by the Board, the FDIC, and the OCC. I appreciate the level of engagement from both banks and community and civil rights stakeholders. The many perspectives we heard helped agencies continue to refine the approach from the proposed rule to the final rule.

Key elements of the final rule include support for minority depository institutions and community development financial institutions as well as adapting the rule to mobile and online banking. Fair lending is safe and sound lending. The new TRA regulations will encourage financial inclusion in important ways, helping to make the financial system safer and fairer.

Thank you. I am happy to take your questions.

You may also like...

Leave a Reply

Your email address will not be published. Required fields are marked *