The Federal Reserve Board (FRB) Chair Janet Yellen testified before the US House of Representatives Committee on Financial Services in Washington DC on September 28, 2016. The testimony on supervision and regulation, rather than monetary policy, points to more regulation and capital requirements for the large “too big to fail” banks, and less for regional banks who are considered “non-systemic.”1 Yellen noted that one of the Fed’s fundamental goals is to tailor the regulatory and supervisory program to the risk posed by the different financial institutions to the system as a whole. She emphasized that Fed regulations have made large financial institutions more resilient in the face of future economic downturns, and limited the damage should they fail.2 Going forward, the Fed will be focused on reducing the burden of regulations on small and medium sized banks. “When it comes to bank regulations and supervision, one size does not fit all,”3 she said. The largest (most complicated) firms should be subject to more stringent prudential standards than the standards applied to other firms, and small and medium-sized banking organizations, whose failure would pose less risk to the system, should be subject to standards that are significantly less stringent.4

What this Means

Yellen devoted much of her testimony to the Fed’s plans for changes to the Comprehensive Capital Analysis and Review (CCAR) stress tests, outlined by Governor Tarullo, the objective of which is to toughen the demands on the largest banks, while relieving smaller lenders of some of the most onerous parts of the annual filing.5 The key idea emerging from the CCAR review is to integrate CCAR with the Fed’s regulatory capital framework. The regulatory capital rules will now include a firm-specific, risk-based capital surcharge for each Global Systemically Important Bank (G-SIB), and a uniform capital conservation buffer requirement above the regulatory capital minimum set for all firms.6 Under this new approach, the existing capital conservation buffer would be replaced with a risk sensitive and firm-specific buffer sized upon the stress test results. This “stress capital buffer” would in effect move the stress test to the center of the Fed’s regulatory capital framework.7 The proposed changes to the CCAR tests would significantly increase the amount of capital that G-SIBs are required to hold, and so would make these institutions more resilient. Yellen also noted that about two dozen banks subject to the CCAR stress tests would not be subject to the more demanding standards, emphasizing that the Fed is considering exempting banks with less than $250 billion in assets, with little non-bank or international presence from parts of the CCAR stress tests.8

In addition to strengthening the regulation of the largest, most complex institutions, the Fed have created the Large Institution Supervision Coordinating Committee (LISCC), to implement a centralized, multidisciplinary approach to supervision. The LISCC will examine these firms through annual “horizontal” programs at the same time, and focusing on the same sets of issues. This should promote better monitoring of trends and enhanced consistency of assessments across all LISCC firms.9

The Fed has also proposed new rules to improve the prospects for the orderly resolution of a G-SIB. The eight US G-SIBs must meet Total Loss-Absorbing Capacity (TLAC) and long-term debt requirements, which would require them to maintain a large quantity of long-term debt that could be used to absorb losses and recapitalize the firm in resolution.10 Non-LISCC banks with more than $50 billion in assets  will not be subject to the same set of rules, as the distress or failure of such a firm is unlikely to have the same effect on the financial system and broader economy.11 Yellen also suggested that smaller financial firms and community banks could be “carved out” of two major Dodd-Frank requirements, the Volker Rule ban on certain types of investments and the proposal that would limit executive bonuses.12

Key Observations and Take-aways

In her concluding remarks Yellen stated that the approach taken by the Fed post-crisis to regulation and supervision is forward looking and tailored to the level of risk firms pose to financial stability and the broader economy. “Standards for the largest, most complex banking organizations are now significantly more stringent than standards for small and medium-sized banks,” Yellen said, adding that the Fed expects to take additional actions in the short term to further tailor the regulatory and supervisory framework. The regulatory future points to raised capital requirements for the biggest banks, with an easing of scrutiny for smaller institutions.13

 

References

  1. “Janet Yellen Addresses Further Regulation and More Capital Reserves at Largest Banks,” 24/7 Wall Street, September 28, 2016. Access at: http://247wallst.com/economy/2016/09/28/janet-yellen-addresses-further-regulation-and-more-capital-reserves-at-largest-banks/.
  2. “Janet Yellen Addresses Further Regulation and More Capital Reserves at Largest Banks,” 24/7 Wall Street, September 28, 2016. Access at: http://247wallst.com/economy/2016/09/28/janet-yellen-addresses-further-regulation-and-more-capital-reserves-at-largest-banks/. “Federal Reserve Chair Janet Yellen: Banks need tailored supervision,” The Washington Post, September 28, 2016. Access at: https://www.washingtonpost.com/news/wonk/wp/2016/09/28/federal-reserve-chair-janet-yellen-banks-need-tailored-supervision/.
  3. “Federal Reserve Chair Janet Yellen: Banks need tailored supervision,” The Washington Post, September 28, 2016. Access at: https://www.washingtonpost.com/news/wonk/wp/2016/09/28/federal-reserve-chair-janet-yellen-banks-need-tailored-supervision/.
  4. Chair Janet L. Yellen, Supervision and Regulation Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C., Testimony, Board of Governors of the Federal Reserve System, September 28, 2016. Access at: https://www.federalreserve.gov/newsevents/testimony/yellen20160928a.htm.
  5. “Yellen Paints Rosy Picture of Wall Street’s Health for Congress,” Bloomberg Markets, September 28, 2016. Access at: http://www.bloomberg.com/news/articles/2016-09-28/yellen-to-say-good-things-about-wall-street-in-house-testimony.
  6. Chair Janet L. Yellen, Supervision and Regulation Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C., Testimony, Board of Governors of the Federal Reserve System, September 28, 2016. Access at: https://www.federalreserve.gov/newsevents/testimony/yellen20160928a.htm.
  7. Ibid
  8. “Federal Reserve Chair Janet Yellen: Banks need tailored supervision,” The Washington Post, September 28, 2016. Access at: https://www.washingtonpost.com/news/wonk/wp/2016/09/28/federal-reserve-chair-janet-yellen-banks-need-tailored-supervision/.
  9. Chair Janet L. Yellen, Supervision and Regulation Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C., Testimony, Board of Governors of the Federal Reserve System, September 28, 2016. Access at: https://www.federalreserve.gov/newsevents/testimony/yellen20160928a.htm.
  10. Ibid
  11. Ibid
  12. “Yellen Paints Rosy Picture of Wall Street’s Health for Congress,” Bloomberg Markets, September 28, 2016. Access at: http://www.bloomberg.com/news/articles/2016-09-28/yellen-to-say-good-things-about-wall-street-in-house-testimony.
  13. Chair Janet L. Yellen, Supervision and Regulation Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C., Testimony, Board of Governors of the Federal Reserve System, September 28, 2016. Access at: https://www.federalreserve.gov/newsevents/testimony/yellen20160928a.htm

Newsletter Author: Samantha Regan, Mairi Bryan

Newsletter Contact Person: Nghi Pham

Visit www.accenture.com/RegulatoryCompliance for latest insights on regulatory remediation and compliance transformation.

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