This regular publication from DLA Piper focuses on helping banking and financial services clients navigate the ever-changing federal regulatory landscape.
Fed drops qualitative test for US banks in 2019 stress tests; keeps CCyB at current level of 0 percent. The Fed announced on March 6 that it will limit the use of the qualitative objection in its Comprehensive Capital Analysis and Review for most US firms, effective for the 2019 cycle, thanks to improvements in capital planning made by the largest firms. The qualitative portion of the 2019 test will, however, still apply to banks that have been participating in the CCAR exercise for less than four years, including five intermediate holding companies of large foreign banks, and banks whose capital plans were rejected the previous year, under the Fed's Amendments to the Capital Plan Rule. Post-financial crisis, the Fed has subjected the largest and most complex banks to both a quantitative evaluation of capital adequacy to determine their ability to withstand a major economic downturn, and an arguably more subjective qualitative assessment that gives the Fed discretion to flunk banks due to risk management or operational failures, even if they are well capitalized. The Fed indicated that it will still scrutinize banks for operational and risk management deficiencies, but will address them through enforcement actions rather than bestowing a publicly announced failing grade. The Fed Board also released instructions for this year's CCAR exercise, under which 18 firms will be subject to the stress test.
- At the same March 5 Board meeting, the Fed voted to affirm the Countercyclical Capital Buffer at its current level of 0 percent. Enacted in 2010 as part of Basel III, a global regulatory framework setting standards for capital adequacy and liquidity, the CCyB aims to ensure that banking sector capital requirements take into account the macro-financial environment in which banks operate and it is designed to be released when economic conditions deteriorate. If the Fed decides to change the CCyB level in the future, there would be 12-month phase-in period. The Fed consulted with FDIC and OCC in making its determination.
- The Fed voted 4-1 in favor of both policy actions, with Fed Gov. Lael Brainard, the only remaining appointee of President Barack Obama, casting the sole dissenting votes.
FSOC to focus on business sector risks rather than individual non-banks. The Financial Stability Oversight Council announced on March 6 a proposal to "implement an activities-based approach to identifying and addressing potential risks to financial stability" in its monitoring of non-bank financial firms, rather than targeting specific companies. The FSOC, chaired by the Treasury Secretary and comprising the leaders the Fed, FDIC, OCC and other major financial regulatory agencies, voted unanimously to propose changes to how nonbanks can be designated as systemically important and subject to enhanced oversight by federal authorities. As part of a report on financial services regulation issued in 2017, Treasury called for an approach based on risky activities rather than singling out individual firms. FSOC would “monitor diverse financial markets and market developments in consultation with relevant financial regulatory agencies" under the proposal. If a potential risk is identified, FSOC work with regulators to develop appropriate measures in response, and conduct a cost-benefits analysis before applying the designation. The proposed interpretive guidance will be open for a 60-day public comment period after it is published in the Federal Register.
Powell doubts CECL will have procyclical effects, but pledges 'appropriate action' if it does. Fed Chairman Jerome Powell told members of Congress that the Fed does not agree with critics who worry that the proposed Current Expected Credit Loss accounting standard will have a procyclical effect on the economy, trigger capital volatility and depress lending, especially to lower-income borrowers, during a downturn. But Powell said the Fed is monitoring implementation of CECL, "And if we find that it does have effects like that, then we'll take appropriate action." During a February 27 House Financial Services Committee hearing, lawmakers from both sides of the aisle confronted Powell with their misgivings about CECL, a credit loss accounting model issued by the Financial Accounting Standards Board in 2016, which is scheduled to go into effect for SEC filers in December 2019, for all other public business entities a year later, and non-public entities a year after that, although early adoption has been permitted since last December. Powell acknowledged concerns raised by banks opposed to the new standard and said the Fed was taking steps, such as the phased-in approach, to minimize disruption. Representative Nydia Velazquez (D-NY) said her concern over CECL was not so much for banks but for “a segment of our population who has been not participating in capital access, such as low-income borrowers or small businesses" But Representative Blaine Luetkemeyer (R-MO) said he was "desperately and very, very concerned about how it's going to affect banks because how it affects banks is going to affect consumers. If banks have to raise their cost of being able to make a loan, that's going to cause people to no longer have the ability to have home loans." Powell also told the committee CECL has not yet been incorporated into the stress testing regimen but “eventually" will be. "It's a decision that FASB made and that we're just implementing." Powell said.
Banking Committee Republicans seek GAO clarification on Fed guidance for large banks. Five GOP senators have asked the US Government Accountability Office to determine if guidance letters issued by the Fed imposing the framework for consolidated supervision of large financial institutions constitute a "rule”"for the purposes of the Congressional Review Act. In a February 22 letter to US Comptroller Gene Dodaro, director of the GAO, the senators note that the Fed has issued guidance letters on its supervision of banks, particularly those overseen by the Large Institution Supervision Coordinating Committee, with requirements for capital, liquidity, corporate governance, and recovery and resolution planning. "Determining whether the LISCC Guidance is a 'rule' under the CRA is particularly important because the Federal Reserve has never revealed the criteria by which certain supervised institutions become subject to (or may avoid becoming subject to) the LISCC designation and associated requirements," the senators wrote. Under the CRA, Congress can overturn regulations through a resolution passed by both houses. Given the compliance burdens that LISCC guidance imposes, the senators suggest that it meets the CRA definition of a "rule" that could be invalidated by Congress. The letter was signed by Banking Committee Chairman Mike Crapo (R-ID) and Sens. Thom Tillis (R-NC), David Perdue (R-GA), Mike Rounds (R-SD), and Kevin Cramer (R-ND). "For too long, Federal regulatory agencies have used rules masquerading as guidance to improperly regulate financial institutions," said Senator Tillis, who spearheaded the letter.
Fed said to be considering tighter liquidity rules for FBOs. The Fed may be looking at imposing tough new liquidity requirements on US branches of foreign banks, according to a March 5 published report in Politico that cites "people familiar with the matter." The potential new rule would have the effect of bolstering the post-crisis oversight of foreign banks, mandating that branches adhere to the same types of obligations to maintain cash reserves that domestic banks now face. In 2014 the Fed required major international lenders to establish intermediate holding companies for their US operations but deferred action on subjecting branches to tightened liquidity requirements. The Institute of International Bankers opposes the emerging proposal. IIB CEO Briget Polichene told Politico that branches of foreign banks are already subject to liquidity and capital requirements in their home countries and urged regulators to adjust their risk factor framework and other calculations in recognition of the unique position of the US branches of foreign-owned banks. Congressional Republicans could try to block implementation of the potential rule, or at least force a significant rewrite, while the tougher requirements are more likely to garner support from Democrats. Senate Banking Committee Chairman Mike Crapo (R-ID) told Fed Chairman Powell at a hearing last month that regulators should "examine where the regulations that apply to the US operations of foreign banks are tailored to the risk profile of the relevant institutions and consider the existence of home country regulations that apply on a global basis."
FFIEC issues policy statement on new format for ROE. The Federal Financial Institutions Examination Council on March 5 issued a Policy Statement on the Report of Examination to update this supervisory communication tool documenting the findings of financial regulatory agencies. At the same time, federal banking agencies rescinded their 1993 Interagency Policy Statement on the Uniform Core Report of Examination. "Considering evolving financial institution supervision processes, advancing technologies, and industry feedback, the FFIEC members concluded that a principles-based approach for completing the ROE would better achieve the objectives of promoting consistency and communication among the members, while allowing individual supervisors the flexibility to document their assessment of financial institutions of different sizes, activities, risk profiles, and financial and managerial conditions," the statement reads. Those principles or "minimal expectations" include conveying the confidential nature of the ROE, presenting conclusions in order of importance, documenting the condition and risk profile of financial institutions as well as issues of supervisory concern, discussing the adequacy of risk management practices, and making sure boards of directors receive and review the ROE. Established in 1979, the FFIEC members include the Fed, FDIC, OCC, CFPB, NCUA and FFIEC's State Liaison Committee.
GAO warns OCC to prevent 'regulatory capture'. The GAO has issued a series of recommendations to the OCC on how it can improve its defenses against "regulatory capture," when regulators act in the interest of the industry they're regulating, rather than in service of the public good. In a report publicly released on February 25, titled " Large Bank Supervision: OCC Could Better Address Risk of Regulatory Capture," GAO said the tendency to advance industry interests "can be a significant problem in banking regulation, where regulators may be swayed by future job offerings and more." Among GAO's criticisms of the agency is what it terms the lack of an OCC policy to determine potential conflicts of interests when it puts together a team to examine a bank. Among GAO's nine recommendations are transparency measures, such as documentation of communications with banks and internal deliberations. The GAO report includes OCC's response, in which it expresses disagreement with most of the recommendations. While OCC's letter states that there is room for improvement regarding documentation procedures, and that OCC has already taken steps to implement some of the GAO recommendations, "we disagree that these documentation concerns increase the risk of regulatory capture. While the OCC remains fully committed to promoting vigilant supervision and independence, we are not convinced that a majority of the recommendations are necessary and achieve this aim." The US Office of Special Counsel issued a letter on February 14 informing the White House and key Congressional committees that between 1996 and 2011, the OCC failed to properly enforce an ethics rule prohibiting federal officials from having a financial interest in the industries they regulate, based on tips from a whistleblower, but credits the agency with conducting a "good faith investigation" and taking "appropriate corrective actions in response to the substantiated allegations."
Regulators may revive bank executive incentive pay limits proposal. Officials from the Fed, FDIC, OCC and other agencies are discussing a long dormant proposal intended to curb compensation incentives and bonuses that could encourage the types of risky actions and short-term thinking that critics have cited as a contributors to the financial crisis, according to a March 5 published report in The Wall Street Journal(subscription required). The newspaper reports that the discussions are still in the early stages, but that Fed and OCC spokespersons confirmed that their agencies are committed to completing work on an incentive-compensation rule. Dodd-Frank mandated new rules to align payouts to firms' financial conditions, but two previous attempts at drafting regulations were thwarted in part by industry opposition. According to the WSJ's analysis, "Some bank executives are open to having the agencies write a new version of the rules, betting the limits would be milder during the Trump administration than if a Democrat takes the White House in 2020."