[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]






                     EXAMINING CAPITAL REGIMES FOR
                         FINANCIAL INSTITUTIONS

=======================================================================

                                HEARING

                               BEFORE THE

                 SUBCOMMITTEE ON FINANCIAL INSTITUTIONS
                          AND CONSUMER CREDIT

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED FIFTEENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 17, 2018

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 115-109




[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]










                                   ______
		 
                     U.S. GOVERNMENT PUBLISHING OFFICE 
		 
31-508PDF                WASHINGTON : 2018                 










                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking 
    Vice Chairman                        Member
PETER T. KING, New York              CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
STEVAN PEARCE, New Mexico            GREGORY W. MEEKS, New York
BILL POSEY, Florida                  MICHAEL E. CAPUANO, Massachusetts
BLAINE LUETKEMEYER, Missouri         WM. LACY CLAY, Missouri
BILL HUIZENGA, Michigan              STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin             DAVID SCOTT, Georgia
STEVE STIVERS, Ohio                  AL GREEN, Texas
RANDY HULTGREN, Illinois             EMANUEL CLEAVER, Missouri
DENNIS A. ROSS, Florida              GWEN MOORE, Wisconsin
ROBERT PITTENGER, North Carolina     KEITH ELLISON, Minnesota
ANN WAGNER, Missouri                 ED PERLMUTTER, Colorado
ANDY BARR, Kentucky                  JAMES A. HIMES, Connecticut
KEITH J. ROTHFUS, Pennsylvania       BILL FOSTER, Illinois
LUKE MESSER, Indiana                 DANIEL T. KILDEE, Michigan
SCOTT TIPTON, Colorado               JOHN K. DELANEY, Maryland
ROGER WILLIAMS, Texas                KYRSTEN SINEMA, Arizona
BRUCE POLIQUIN, Maine                JOYCE BEATTY, Ohio
MIA LOVE, Utah                       DENNY HECK, Washington
FRENCH HILL, Arkansas                JUAN VARGAS, California
TOM EMMER, Minnesota                 JOSH GOTTHEIMER, New Jersey
LEE M. ZELDIN, New York              VICENTE GONZALEZ, Texas
DAVID A. TROTT, Michigan             CHARLIE CRIST, Florida
BARRY LOUDERMILK, Georgia            RUBEN KIHUEN, Nevada
ALEXANDER X. MOONEY, West Virginia
THOMAS MacARTHUR, New Jersey
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana

                     Shannon McGahn, Staff Director
       Subcommittee on Financial Institutions and Consumer Credit

                 BLAINE LUETKEMEYER, Missouri, Chairman

KEITH J. ROTHFUS, Pennsylvania,      WM. LACY CLAY, Missouri, Ranking 
    Vice Chairman                        Member
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
BILL POSEY, Florida                  DAVID SCOTT, Georgia
DENNIS A. ROSS, Florida              NYDIA M. VELAZQUEZ, New York
ROBERT PITTENGER, North Carolina     AL GREEN, Texas
ANDY BARR, Kentucky                  KEITH ELLISON, Minnesota
SCOTT TIPTON, Colorado               MICHAEL E. CAPUANO, Massachusetts
ROGER WILLIAMS, Texas                DENNY HECK, Washington
MIA LOVE, Utah                       GWEN MOORE, Wisconsin
DAVID A. TROTT, Michigan             CHARLIE CRIST, Florida
BARRY LOUDERMILK, Georgia
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York

































                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 17, 2018................................................     1
Appendix:
    July 17, 2018................................................    37

                               WITNESSES
                         Tuesday, July 17, 2018

Baer, Hon. Greg, President, Bank Policy Institute................     5
Fromer, Hon. Kevin, President and Chief Executive Officer, 
  Financial Services Forum.......................................     4
Holtz-Eakin, Douglas, President, American Action Forum...........     7
Noreika, Keith A., Partner, Simpson Thacher & Bartlett...........    10
Stanley, Marcus, Policy Director, Americans for Financial Reform.     9

                                APPENDIX

Prepared statements:
    Baer, Hon. Greg..............................................    38
    Fromer, Hon. Kevin...........................................    67
    Holtz-Eakin, Douglas.........................................    78
    Noreika, Keith A.............................................    84
    Stanley, Marcus..............................................   101

              Additional Material Submitted for the Record

Clay, Hon. Wm. Macy:
    Comment letters from Americans for Financial Reform (AFR)....   109
    Written statement from Better Markets, Inc...................   153
    Written statement from the Center for American Progress......   184
    Written statement from Stephen G. Cecchetti and Kermit L. 
      Schoenholtz................................................   234

 
                     EXAMINING CAPITAL REGIMES FOR  
                         FINANCIAL INSTITUTIONS

                              ----------                              


                         Tuesday, July 17, 2018

                     U.S. House of Representatives,
                     Subcommittee on Financial Institutions
                                       and Consumer Credit,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 2:02 p.m., in 
room 2128, Rayburn House Office Building, Hon. Blaine 
Luetkemeyer [chairman of the subcommittee] presiding.
    Present: Representatives Luetkemeyer, Rothfus, Lucas, 
Posey, Ross, Pittenger, Barr, Tipton, Williams, Trott, 
Loudermilk, Kustoff, Tenney, Clay, Maloney, Scott, Green, Heck, 
and Crist.
    Chairman Luetkemeyer. The committee will come to order. 
Without objection, the Chair is authorized to declare a recess 
of the committee at any time. This hearing is entitled, 
``Examining Capital Regimes for Financial Institutions.''
    Before we begin, I would like to thank the witnesses for 
appearing today. We appreciate your participation. And, quite 
frankly, everybody is jealous of our panel today. We have a 
very, very distinguished panel. Thank you, all, for being here, 
and we certainly look forward to and anticipate your testimony.
    I now recognize myself for 5 minutes for purposes of 
delivering an opening statement.
    Last April, this subcommittee held a hearing to examine the 
state of Federal financial regulation and the impact regulators 
and their perspective regimes were having on institutions, 
their customers and the U.S. economy. Sitting on the front row 
of the dais were stacks of paper representing 20,000 to 30,000 
pages the average bank submits to the Federal Reserve for its 
annual CCAR (Comprehensive Capital Analysis and Review) review 
process. That is 20,000 to 30,000 pages per bank per year just 
for CCAR.
    Fast forward a little more than a year, and I am pleased to 
report that the first time, in a long time, progress has been 
made and some relief has been granted. Thanks, in large part, 
to the effort of the Members of this committee and our 
colleagues in the Senate and a President who champions 
regulatory reform.
    CCAR doesn't burden nearly as many institutions as it did 1 
year ago. While some relief has been seen, it is widely 
recognized that there is more work to be done.
    In a January speech, the newly minted Federal Reserve Vice 
Chairman for Supervision, Randy Quarles, outlined his vision by 
stating that, and I quote, ``simplicity of regulation is a 
principle that promotes public understanding of regulation, 
promotes meaningful compliance by the Industry of Regulation,'' 
and reduces unexpected negative in synergies among regulations. 
Confusion that results from overly complex regulation does not 
advance the goal of a safe system. End quote.
    Vice Chairman Quarles went on to indicate support for 
changes to the resolution planning process and stress-test 
programs, acknowledging substantial progress made by financial 
institutions in the last few years.
    His quasi predecessor, Governor Dan Tarullo, said in his 
departure speech last year, and I quote, ``the time may be 
coming when the qualitative objection in CCAR should be phased 
out and supervisory examination work around stress testing and 
capital planning completely moved into the normal, year-round 
supervisory process, even for G-SIBs.'' End quote.
    While we didn't agree on much during his tenure, Governor 
Tarullo and I had at least one thing in common, the idea that 
capital is a good thing. Capital protects institutions and 
for--and, more importantly, consumers against loss and guards 
the financial system against threats of collapse. While I 
believe in robust capital requirements, I don't think capital 
should be required to the point that it consolidates risk and 
eliminates choice in the marketplace for commercial individual 
clients.
    The reality is that we still live in a world where the 
financial regulatory regime stifles growth and limits the 
availability of financial products. The new crop of Federal 
financial regulators, in an effort to right-size regulation, 
are considering additional measures, including tailoring to 
provide relief to institutions of all sizes. As they do so, I 
would first urge them to implement the statutory changes, 
included in Senate bill 2155 without delay and do so while 
closely adhering to what is clear congressional intent.
    It is time for the Federal Reserve to also conduct a 
holistic review and acknowledge that the world has changed 
since the enactment of Dodd-Frank and the finalization of the 
capital requirements on the books today. Such review should 
include a consideration of equal and reasonable treatment for 
institutions with more than $250 billion in assets and for 
immediate holding companies--or intermediate holding companies 
of international banks operating in the United States.
    These institutions should be subjected to tailored 
regulation that reflects the risk they pose to the financial 
system. Such steps would not only reflect the intent of 
Congress but also the Administration, evidenced most clearly 
through the recommendations issued by the Treasury Department 
since President Trump took office.
    It is time to take the guessing out of capital planning and 
regulation. I press leadership at each of the Federal financial 
regulatory agencies to recommit to greater transparency and 
adherence to the requirements in the Administrative Procedures 
Act. We need smarter streamlined regulatory regimes that 
promote not just transparencies, but also effective tax payer 
and systemic protections.
    We have a very distinguished panel of witnesses before us 
today. Each of these gentlemen has an honorable background, and 
we appreciate their testimony.
    The Chair now recognizes the Ranking Member of the 
subcommittee, the gentleman from Missouri, Mr. Clay, for 5 
minutes for an opening statement.
    Mr. Clay. Thank you, Mr. Chair, and thank you for 
conducting this hearing. At this time, I am going to be going 
back and forth to a business meeting in the Oversight and 
Government Reform Committee. We are expecting votes, so I will 
designate Mr. Scott, of Georgia, as the ranking Democrat on the 
panel. And I yield to him on his opening statement.
    Chairman Luetkemeyer. Very good. We will recognize Mr. 
Scott for an opening statement.
    Mr. Scott. Thank you, Mr. Chairman. Thank you, Mr. Clay.
    As was pointed out by the Chairman in his opening remarks, 
it is important for us to remember that stress tests are an 
important tool that we armed our regulators with in the 
aftermath of the terrible financial crisis. And we did that so 
that regulators can test the health of our country's biggest 
banks.
    And I was, back then, very proud of the fact that I was an 
original co-sponsor of Dodd-Frank. And I am proud to say this, 
that if it weren't for the most stringent capital leverage 
requirements that we put in place, our financial system 
wouldn't be as safe as it is today. These changes have also 
made our banks more resilient. And they have led to increased 
bank lending, which helped spur our great economic growth that 
we are experiencing today.
    These changes also have made our banks more active in 
getting the necessary capital out into the marketplace. But as 
I have been saying for quite a while in our numerous committee 
meetings, no law is perfect. And that is to say Dodd-Frank is 
not perfect.
    And we, as lawmakers, cannot be unwilling to look at these 
Dodd-Frank rules, simply because they are too politically 
difficult to discuss. Our banking system needs us to do that. 
That is why I became the Democratic leader of Mr. Zeldin's 
Stress Test Improvement Act HR4293.
    We have a distinguished panel. We are looking forward to 
your interesting and helpful comments. And thank you, Mr. 
Chairman. I yield back.
    Chairman Luetkemeyer. The gentleman yields back. With that, 
we go to the testimony of our witnesses. Today, we welcome the 
Honorable Kevin Fromer, President and CEO of Financial Services 
Forum; the Honorable Greg Baer, President and CEO of Bank 
Policy Institute; Dr. Douglas Holtz-Eakin, the President of 
American Action Forum; Dr. Marcus Stanley, Policy Director of 
Americans for Financial Reform; and Mr. Keith Noreika, Partner 
at Simpson Thacher & Bartlett.
    Each of you will be recognized for 5 minutes to give an 
oral presentation of your testimony. Without objection, each of 
your written statements will be made part of the record. Just a 
quick tutorial on the microphones in front of you. Please 
pull--that whole thing will come forward. All you do is just 
pull the whole thing forward. And make sure you are--the 
microphone is close. It is very sensitive. Red means--or green 
means go, yellow means you have a minute to wrap up, and red 
means we need to close down all together.
    So, with that, Mr. Fromer, your recognized for 5 minutes. 
Welcome.

                 STATEMENT OF HON. KEVIN FROMER

    Mr. Fromer. Thank you, Mr. Chairman, and Congressman Scott 
and Members of the subcommittee. Thank you for having this 
hearing and thank you for the opportunity to testify today.
    My name is Kevin Fromer, and I am President and CEO of the 
Financial Services Forum. Our members are the eight largest and 
most diversified financial institutions headquartered in the 
United States. And we welcome the opportunity to discuss our 
support for a broad review of U.S. capital regulations, as well 
as a more targeted review of the capital planning process, the 
leverage ratio, and the capital surcharge which applies to only 
our members.
    The Forum's member firms provide vital services in support 
of the U.S. economy. In the first quarter, Forum institutions 
held more than $4 trillion in loans, accounting for 44 percent 
of total lending to businesses and households.
    Our members also underwrite nearly three-quarters of debt 
and equity transactions among other large U.S. institutions, 
providing critical services that other institutions cannot 
provide on a similar scale.
    Our institutions have significantly enhanced their 
resiliency and resolvability over the past decade. And they are 
strongly positioned to support economic growth throughout the 
economic cycle. Notably, they maintain more than $900 billion 
in tier one capital, a more than 40 percent increase since 
2009.
    Our member institutions also have significantly improved 
their liquidity positions, holding nearly $2 trillion in high-
quality liquid assets, an increase of more than 85 percent 
since 2010. Our members maintain strong capital levels, and 
they support capital standards that promote both stability and 
economic growth.
    Since capital is a more expensive form of bank funding, 
unwarranted increases in capital standards lead to increased 
costs of borrowing and reduced availability of loans for 
consumers, businesses and communities. To foster economic 
growth, it is imperative that capital standards be 
appropriately calibrated to effectively balance costs and 
benefits.
    Regulators worldwide have issued many new requirements at a 
significant pace in recent years, necessarily focusing on each 
measure individually. With nearly a decade of change and 
experience and data behind us, now is the time for a holistic 
review of the interaction of these important but separate 
actions. Regulators here and abroad have already begun that 
process of reviewing and adjusting the post-crisis regulatory 
system to make key rules operate with greater transparency and 
efficiency.
    An important initial step in this regard was a series of 
recommendations made by the Treasury Department last year. In 
my testimony, we call for a broad review and highlight our 
views on targeted near-term steps. The Federal Reserve, this 
year, proposed to integrate its capital regulatory rule with 
its capital planning and stress testing regime, while 
establishing a new stress capital buffer.
    In addition, two Federal banking agencies proposed to 
revise the enhanced supplementary leverage ratio which applies 
to only our members. These efforts, which we appreciate, seek 
to maintain strong capital adequacy while reducing the 
complexity, cost, and unintended consequences of the 
regulations.
    The Forum has offered suggestions for improving these 
proposals. First, the Forum believes that the stress capital 
buffer proposal should be modified to ensure that boards of 
directors at financial institutions can clearly and 
appropriately make capital management decisions. A firm with 
capital in excess of the Federal Reserve's requirements should 
be permitted to make capital distributions in the way its board 
deems most productive. The Federal Reserve should also improve 
the transparency of its scenario and model designs by, for 
example, soliciting public comment on its stress scenarios.
    Finally, the Federal Reserve should conduct full set 
analysis of the effective costs and benefits of the proposed 
stress capital buffer proposal that accounts for the full range 
of its economic costs.
    Secondly, with respect to the enhanced supplementary 
leverage ratio proposal, we have recommended that the agencies 
exclude risk-free assets to eliminate the economic incentive to 
reduce participation in low-risk, low-return businesses.
    These changes would also serve the agencies' stated goal of 
ensuring that leverage requirements serve as a backstop to 
risk-based capital as opposed to a binding constraint.
    Finally, both the stress capital buffer and leverage 
proposals import the G-SIB (global systemically important bank) 
capital surcharge which, again, only applies to our members. 
This surcharge was finalized in 2015, 3 years ago, in the 
absence of several very important improvements to the 
regulatory system.
    In conjunction with our colleagues at the Bank Policy 
Institute, we have analyzed the level of the G-SIB surcharge 
and find that it is overstated by at least 1 percent because of 
subsequent additional regulatory requirements, which both 
reduce the risk and the impact of default to the financial 
system.
    Accordingly, we believe that the G-SIB surcharge should be 
reconsidered. This is an initiative that would be wholly 
consistent with the stated intent by regulators to reexamine 
and reevaluate the efficacy and efficiency of the proposed 
crisis regulatory regime.
    We look forward to continued engagement with the Congress, 
with regulators, and other stakeholders to achieve a balanced 
system that seeks the goals of a safe and sound system with one 
that best supports economic growth and job creation.
    Thank you.
    [The prepared statement of Mr. Fromer can be found on page 
67 of the Appendix.]
    Chairman Luetkemeyer. Mr. Baer, you are recognized for 5 
minutes.

                   STATEMENT OF HON. GREG BAER

    Mr. Baer. Thanks. Chairman Luetkemeyer and Members of the 
subcommittee, today is my first testimony on behalf of the New 
Bank Policy Institute (BPI). Our new organization will conduct 
research and advocacy on behalf of America's leading banks, 
which will also serve the interest of consumers who desire 
innovative products at competitive prices and businesses who 
seek funding for their growth. The stakes are high as our 
members make 72 percent of all loans and 44 percent of all 
small business loans.
    Turning to capital regulation, U.S. banks now hold 
substantial amounts of high-quality capital. Since the global 
financial crisis, BPI's 48 members have increased their 
collective tier one common equity from nearly $400 billion to 
almost $1.2 trillion.
    As a barometer for just how much capital the largest banks 
are carrying in 2018, consider this year's CCAR results. I 
should note that BPI's smaller non-CCAR banks have even higher 
capital ratios than the largest. The scenario included a sudden 
increase in the unemployment rate of 600 basis points. In the 
stock market crash of 65 percent, housing prices plunged 30 
percent. And a similar shock hit capital markets.
    Using the Federal Reserve's own monetary policy 
projections, we calculate that such a rapid increase in the 
unemployment rate alone, leaving aside all the other shocks, 
has only about a 50-50 chance of occurring once every 10,000 
years. And yet, in this year's CCAR exercise, banks ended up 
highly solvent, holding a ratio of tier one common equity risk-
based assets ranging from 4.0 to 16.2 percent.
    Over-capitalization of the bank sector matters because 
every major evaluation of the cost and benefits of capital 
requirements, including those done by the Basel Committee, the 
Federal Reserve, the Bank of England, and the IMF find, it is 
lending to clients with higher capital requirements. The only 
debate is how much?
    Another underestimated adverse consequence of capital 
regulations stems from volatility. We frequently hear from bank 
CFOs that capital planning is extremely difficult when capital 
requirements vary dramatically year to year, whether from CCAR 
stress testing scenarios and model changes or examiner 
pressure.
    The final overarching concern is the credit allocation 
inherent in today's regime. One bank CFO recently remarked to a 
colleague that he is no longer in the banking business but 
rather in the regulatory optimization business. In other words, 
choosing business lines not based on the bank's own estimate of 
the risk adjusted returns, but rather on how they are treated 
by capital or liquidity regulations.
    At the moment, the Federal banking agencies are considering 
a variety of rules that could ameliorate or exacerbate these 
issues. One pressing concern is how the agencies will adopt the 
new CECL, or Current Expected Credit Loss, accountable 
methodology for loan loss reserving.
    CECL was originally proposed by the FSB as a counter-
cyclical measure. However, the strong sense of our banks, now 
validated by a study we have just published this week, is that 
it will have precisely the opposite effect. As a result, any 
future recession will be far less, unless the bank regulators 
take offsetting action.
    More immediately, as 2155 revises the thresholds for 
imposing enhanced prudential standards in three ways. First, 
the institutions under 100 billion are no longer subject to 
enhanced prudential standards, full stop.
    Second, institutions between 100 and 250 billion in assets 
will become exempt from most of those standards in 18 months, 
unless the Federal Reserve determines otherwise by rule or 
order. This review should include living wills. And, as Vice 
Chair Quarles recently indicated, the LCR.
    Third, 2155 requires the Federal Reserve to differentiate 
how it applies any enhanced prudential standard, based on the 
firm's complexity. We believe that as the Fed considers how to 
implement 2155, it should suspend application of many of the 
enhanced standards while it decides what to do.
    I should also note the tailoring should include 
international banks headquartered overseas and doing business 
in the United States. Their U.S. regulation presents unique 
issues as such a firm might be a G-SIB in Europe but a regional 
bank in the United States. Yet, current regulation does not 
consider those issues in a nuanced way.
    In April, the Federal Reserve and OCC (Office of the 
Comptroller of the Currency) proposed to revise the enhanced 
supplementary leverage ratio. We generally support that 
proposal as it would return the leverage ratio to serving as a 
backstop.
    We also generally support the Federal Reserve's recent 
proposal to simplify capital requirements whereby any stress 
capital buffer is added to a steady statement on capital 
requirement, rather than being run as an annual pass/fail 
exercise.
    Nonetheless, we believe that before the Fed finalizes such 
a proposal, it must remedy fundamental problems with its stress 
testing regime and resolve significant methodological problems 
with a G-SIB surcharge.
    In particular, the Fed operates CCAR using a mono-model, 
mono-scenario approach, which we believe produces an inaccurate 
picture of risk, provides--produces unjustifiable volatility, 
concentrates risk and allocates capital, principally away from 
small businesses, LMI borrowers and capital markets' activity.
    All in all, it is a lot for regulators in this community to 
consider. We hope to help and welcome your questions.
    [The prepared statement of Mr. Baer can be found on page 38 
of the Appendix.]
    Chairman Luetkemeyer. Thank you, Mr. Baer. Dr. Holtz-Eakin, 
you are recognized for 5 minutes.

              STATEMENT OF DR. DOUGLAS HOLTZ-EAKIN

    Dr. Holtz-Eakin. Thank you, Mr. Chairman and Congressman 
Scott and Members of the committee. It is a privilege to be 
here today. I want to applaud the committee's efforts at 
continuing to optimize the capital regimes that face U.S. 
banks. Unquestionably, Dodd-Frank produced a better capitalized 
banking sector and one that is safer, but it did so at some 
fairly well-documented costs.
    It is an enormously expensive regulatory initiative. It 
costs about $40 billion to comply already and that tab goes up 
every year. In part, because of those costs, we have seen only 
a handful of new banks enter the market in the United States. 
Something that I have considered a very troubling development 
from the point of view of the competition in the banking 
sector.
    On top of that, we have seen a documented decline in the 
access of small businesses to credit and that has a spill-over 
impact on the capacity of those businesses to grow, to hire 
people, and to provide the wages of our labor force.
    At the other side of the market, we have seen a loss in 
some consumer benefits, like free checking accounts. And I 
think, overall, there is an increasing body of evidence that 
suggests that Dodd-Frank came at too high of a cost for the 
benefits that it produced.
    So, I applaud the recent efforts of this committee and the 
Congress in the Economic Growth, Regulatory Relief, and 
Consumer Protection Act, which tailored the regulatory regime 
to take some of those costs off smaller banks, which will 
reverse some of the impacts that we have seen.
    But I don't think that leaves us with no work left to do. I 
think there are some things that I have highlighted out of my 
written testimony. Number one, among the attributes that Dodd-
Frank emphasized in thinking about capital regimes was 
macroprudential regulation or systemic risk issues. To my eye, 
there has been no real success in identifying a good measure of 
systemic risk that regulators can target and appropriately 
manage.
    Instead, that regime has turned into simply a second layer 
of prudential regulation. I would encourage the committee to 
think about holistically reviewing all of those efforts, from 
the point of view of having only a single layer of prudential 
regulation that actually works.
    And in that regard, I want to commend the Federal Reserve 
for its use of stress tests. Stress tests are a very powerful 
tool to look at the capacity of institutions to weather 
financial stress and economic downturns. When done well, that 
is to say with a sufficient transparency, reliance on more than 
a single scenario, they can accomplish great prudential 
regulation by allowing the stress test to reveal the complexity 
of a bank's activities in its capacity to weather those 
difficulties.
    So, I would encourage them to use more stress testing as a 
bulwark of the regime, not less. And certainly, at least to my 
eye, this has the additional advantage of bringing market 
discipline as a complement to the regulatory regime.
    If stress tests reveal that an institution is weak, markets 
will identify that weakness. They will price it appropriately. 
And they will bring pressure on that institution to correct its 
capital backing. And there is no substitute for good capital to 
survive downturns.
    So, I think that is a place to focus going forward. And I 
also think that those tests should be conducted not as part of 
having the Federal Reserve tell banks how they can use their 
money. They should be tested to say, is this bank sufficiently 
capitalized to operate safely in the United States. And past 
that, they should be able to do with whatever dividends and 
other cash distributions they see fit with their money.
    And so, we have made enormous progress. That progress has 
come with somewhat of a price, in terms of growth and benefits 
to consumers of small businesses. We can continue to make 
progress and I would encourage the committee to continue to 
work on that.
    [The prepared statement of Dr. Holtz-Eakin can be found on 
page 78 of the Appendix.]
    Chairman Luetkemeyer. Thank you, Dr. Holtz-Eakin. I 
appreciate your comments. Dr. Stanley, you are recognized for 5 
minutes. Welcome.

                 STATEMENT OF DR. MARCUS STANLEY

    Dr. Stanley. Thank you, Chairman Luetkemeyer and Members of 
the subcommittee, for the opportunity to testify today.
    Today's hearing examines capital regimes for financial 
institutions. In thinking about regulatory capital 
requirements, I believe it is important to start with, first, 
the principles. This begins with understanding that large banks 
receive extensive backing from the Federal Government.
    According to the Federal Reserve Bank of Richmond's latest 
bail-out barometer, almost 80 percent of the liability of all 
banking institutions or $15 trillion benefits from an explicit 
or implicit promise of support from the taxpayer. This support 
ranges from deposit insurance to the kind of long-term 
emergency assistance that was provided by the Federal Reserve 
and Treasury during the financial crisis and continues to be 
authorized under the Dodd-Frank Act.
    Public guarantees are a cornerstone of the modern financial 
system. I guarantee you that if any Member of this committee 
advanced legislation that significantly cut back on those 
public guarantees for the financial system, the very same 
people who ask you for less regulation today would be in your 
office tomorrow opposing that bill.
    Given the government guarantees provided the for-profit 
entities in the financial sector, it is important to require 
that these private entities put up significant resources of 
their own, especially by investing their own private equity 
capital. In the absence of such capital requirements, companies 
could take advantage of low-cost funding made possible by 
guarantees--government guarantees and take the profit upside 
while leaving losses to be covered by the taxpayer. That is 
what we saw in the 2008 crisis.
    Even with post-crisis regulatory capital requirements in 
place, banks are able to borrow much more than any other 
private sector business could. A private nonfinancial firm 
might be able to borrow an amount equal to half its assets. An 
aggressive financial firm outside the public safety net, like a 
medium-sized hedge fund, would typically borrow 60 to 80 
percent of the value of its assets. But the large banks at the 
center of our financial system today all routinely borrow 
amounts over 90 percent of their total asset value.
    Simple math says that the less capital these banks are 
required to invest, the greater their profit return on each 
unit of equity. So, the easiest way for large banks to increase 
their return on equity is to convince you, the legislators, to 
reduce their required levels of capital.
    To do this, they make two arguments. The first argument is 
that you should be complacent. Because the current requirements 
for capital and other loss absorbency are so far in excess of 
any possible losses from a financial crisis that there is no 
way that 2008 could ever happen again. Of course, no one 
expected 2008 to happen before 2008 either.
    The second argument is that you should be alarmed because 
the current regulatory capital requirements impose severe costs 
on the economy. Both of these arguments are mistaken. First, 
you should not be alarmed. Bank lending, especially business 
lending, is growing significantly faster than general economic 
growth which indicates that the banking sector is not acting as 
a drag on economic growth.
    Capital is a resource that is actively deployed. Capital 
supports lending, making lending safer and more durable. Better 
capitalized banks lend more during downturns.
    To the extent capital does increase bank costs, reasonable 
estimates of the economic cost of increased capital are already 
routinely taken account by right--into account by regulators 
and setting bank capital requirements.
    Multiple impartial studies show that current requirements 
are, if anything, too low compared to their economically 
optimal level. You should also not be complacent. While bank 
loss absorbency has increased from the disastrously inadequate 
levels observed before the financial crisis, it is still far 
from clear that it is sufficient to fully protect against the 
risk of another financial crisis. However dramatic the 
microeconomic variables used by the Federal Reserve in stress 
test scenarios, the underlying stress test models that project 
scenario losses are still showing estimated loss is much less 
than those actually experienced by banks during the financial 
crisis.
    And most of all, you must not be complacent because of the 
devastating economic impacts of financial crises. The last 
crisis produced some--created some $10 trillion in direct 
economic cost to the U.S. alone. Nine million lost jobs. 
Millions of families foreclosed from their homes. And shook the 
legitimacy of both our economic and political system. It must 
not be permitted to happen again.
    [The prepared statement of Dr. Stanley can be found on page 
101 of the Appendix.]
    Chairman Luetkemeyer. Thank you, Dr. Stanley. Mr. Noreika, 
you are recognized for 5 minutes. Welcome.

                   STATEMENT OF KEITH NOREIKA

    Mr. Noreika. All right. Mr. Chairman, Ranking Member Scott, 
and Members of the subcommittee, thank you for having me here 
today. During 2017, I had the honor to serve as the Acting 
Comptroller of the Currency. Today, I hope to give you my 
perspective as someone recently familiar with both the concerns 
of the public and private sectors.
    I will focus my remarks on the need for tailoring two 
important segments of the financial system. First, regional 
banks with between $100 and $250 billion in total consolidated 
assets. And, second, international banking organizations that 
have a banking and capital markets presence in the U.S.
    In Dodd-Frank, Congress stated that the Federal Reserve, 
quote, ``may differentiate among companies on an individual 
basis by category, taking into consideration their capital 
structure, riskiness, complexity, financial activity, size and 
any other risk-related factors.''
    Despite this invitation to tailor, the vast majority of the 
Federal Reserve's enhanced prudential requirements have been 
applied to all firms based on simple asset measures. In a 
recent enactment of the regulatory relief legislation in May, 
Congress has now directed the Federal Reserve to tailor its 
requirements to the riskiness of the institutions that it 
supervises.
    With respect to regional banks, the Act first presumes that 
all firms with less than $250 billion in total consolidated 
assets are no longer covered by enhanced prudential 
requirements. And to apply them, the Federal Reserve must 
affirmatively demonstrate that the requirements are appropriate 
to prevent risks to financial stability or to promote safety 
and soundness, and there have been no such risks currently 
identified for such firms.
    Second, the Act requires that the application of any 
enhanced prudential requirement to a firm with at least $100 
billion in total consolidated assets must take into account a 
statutory multi-part conjunctive test. Third, Congress has 
required separate analyses for assessing the application of 
each enhanced prudential requirement.
    And, finally, as the Federal Reserve proceeds to implement 
the Act, the substantive requirements of each of the enhanced 
prudential standards should also be revisited, reexamined, and 
tailored to ensure that the substance of each requirement is 
appropriate based on the risk posed by the subject firm.
    With respect to the application of enhanced prudential 
requirements to international banking organizations, since the 
passage of the International Banking Act in 1978, the 
regulation of international banks operating in the U.S. has 
been guided by a nondiscrimination principle of, quote, 
``national treatment and equality of competitive opportunity.''
    Congress' commitment to national treatment was reaffirmed 
in Dodd-Frank. The implementation of enhanced prudential 
requirements has not always lived up to Congress' mandate of 
national treatment, most notably through the implementation of 
an intermediate holding company requirement on firms with more 
than $50 billion in U.S. non-branch assets; and a variety of 
prescriptive governance, risk management, capital, liquidity, 
stress testing, and resolution planning requirements on the 
U.S. operations of international banks.
    The U.S. ring-fencing requirements and reactive foreign-
ring fencing requirements cause a net increase in capital costs 
on international firms and U.S. firms operating abroad as 
countries apply stand-alone capital and liquidity requirements. 
This may have the perverse effect of making banks with cross-
border activities less safe because if a crisis in one 
geography burns through the firm's local prepositioned 
resources, the firm may be precluded from using its resources 
located elsewhere to bolster the part of its operation under 
stress.
    There are a number of actions that the Federal banking 
agencies should take to reintroduce national treatment into 
their regulation of the U.S. operations of international banks. 
First, the agencies should better account for the global 
resources of international firms when calibrating capital, 
liquidity, and stress testing requirements applied to the U.S. 
operations of these firms.
    Second, consistent with the June 2017 Treasury Report 
recommendations, the requirements applicable to the U.S. 
operations of international banks should be commensurate with 
the risks posed by their U.S. footprints.
    Finally, the current CCAR framework disadvantages 
international firms, whose U.S. operations are primarily 
capital markets in nature and does not take into account the 
benefits of global diversification that exists for these 
international banks.
    Thank you and I look forward to your questions.
    [The prepared statement of Mr. Noreika can be found on page 
84 of the Appendix.]
    Chairman Luetkemeyer. Thank you, Mr. Noreika. I appreciate 
your testimony today and all of the gentlemen here that are on 
our panel today.
    With that, we will begin the questioning. I will recognize 
myself for 5 minutes.
    I guess, Mr. Noreika, we can start with you. With regards 
to implementing Senate Bill 2155, do you see any ambiguity in 
the way that the $250 billion threshold was set?
    Mr. Noreika. Could you repeat that?
    Chairman Luetkemeyer. Yes. Do you see any ambiguity in the 
way that the $250 billion threshold was set or is the statute 
pretty clear?
    Mr. Noreika. I think the--yes. No, thank you.
    Chairman Luetkemeyer. Because you were talking about this 
in your statement here just now and talking about concerns on 
how this should be done. Have you seen any concerns at this 
point with it not being done?
    Mr. Noreika. Well, look, I think the statute is clear. The 
statute presumes that these banks are out unless a 
determination is made, both that there is a risk of financial 
stability of the United States or safety and soundness of the 
institution. And a multi-part statutory test is applied to each 
prudential standard to reapply to those banks.
    Now, I think we heard from the Chairman of the Federal 
Reserve today in his testimony, in an exchange with Senator 
Warner, that they are working on this. And I think the effort 
is to urge the Federal Reserve to apply the statute as it is 
written to, I think, immediately lift the enhanced prudential 
requirements on these banks until and unless they can 
empirically demonstrate that there is a need for each of the 
prudential requirements to apply to each of the institutions in 
this asset range.
    Chairman Luetkemeyer. Well, and I know the procurement 
period on this is disclosed. And I am sure they are listening, 
so has anybody got a comment they would like to make to the Fed 
that say, hey, we suggest this? Nobody has a comment to make to 
the Fed today? Really? OK. I have a lot of them. But we will 
stop there.
    With regards to--Dr. Holtz-Eakin, you were talking about 
the stress test and the importance of it. And I think you made 
a comment, something to the effect that it was--you don't think 
it is quite as good as it could be because it doesn't quite 
accurately measure the stress that banks are under. Can you 
elaborate a little on that?
    I would agree with you, probably to a point. You can't--it 
is difficult to guess what kind of stress can come--where it 
can come from and all of the different variables so who knows 
what is going to happen. But what would you see as some extra 
things that the Fed could do or perhaps, that we could do to 
enable this to be a better situation?
    Dr. Holtz-Eakin. So, I think there are really two areas. 
The first is the transparency and the public nature of the 
information revealed by the stress test. If you think back to 
the first stress tests when they were done, the original plan 
was not to make the results public. And markets were in turmoil 
and there was an enormous amount of fear and uncertainty.
    And when they decided to actually reveal those stress 
tests, it allowed market participants to identify healthier 
versus less healthy institutions pretty clearly. It allowed 
them to price those risks more effectively. And it allowed them 
to bring market discipline to the operation of those banks. It 
is important that that continue going forward.
    I am concerned, my comment to the Fed, about this plan to 
simply move away from having stand-alone stress tests, put 
everything into a CCAR process that doesn't look terribly 
transparent to me. I think that is giving up the opportunity to 
have market discipline as a complement to good regulation. And 
you need both. So, that is point number one.
    The second point is, I am not a big fan of a single 
scenario stress test. Stress tests are done by lots of 
institutions for their own purposes and they involve multiple 
kinds of scenarios to test, genuinely, their exposure to 
different kinds of downturns, different kinds of commodity 
price fluctuations, different kinds of housing market impacts. 
I would encourage the Fed to think more about bringing that 
kind of a regime into play.
    Chairman Luetkemeyer. Well, along that line, Governor 
Tarullo in my comments, I indicated that he made the comment 
that stress testing programs should move to the normal 
examination cycle. And, to me, I think that is where it needs 
to go. I don't know if the banks need to be filling out forms 
to have the regulators see if they have guessed right on 
whether this is actually going to work.
    To me, the regulators should have a set of scenarios that 
they believe could happen. They go into a bank and they apply 
those scenarios to the business model and the actual bank 
members and see if it works. Is that something that makes sense 
to you?
    Dr. Holtz-Eakin. I whole-heartedly concur. I think that is 
exactly the right way to use them. And reveal those results and 
that would be a good way to do prudential regulation. In the 
end, you want good safety and soundness regulations and stress 
tests can be an important part of that.
    Chairman Luetkemeyer. My time has almost expired. With 
that, I will yield back the balance of time and I will go to 
the distinguished gentleman from Georgia. Mr. Scott is 
recognized for 5 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman. Mr. Baer, let 
me start with you. I wanted to ask your thoughts--ask you for 
your thoughts on stress tests because, as I mentioned earlier 
in my opening remarks, my bill with Mr. Zeldin makes structural 
changes to the stress test regime in the--in this way. Our bill 
made such structural changes as saying the Fed couldn't fail a 
bank for their qualitative portion of their test. And we also 
eliminated the adverse scenario from the test requirements, 
among other things.
    But recently, from the Fed, as we all saw for the first 
time, handed out a passing grade when a passing grade wasn't 
deserved. The Fed referred to this as, quote, ``a conditional 
nonobjection'' It is interesting to know what that means.
    But I also view the amendments we made in my bill with Mr. 
Zeldin as a way to reduce the burden without fully gutting 
these critical, important tests. But I viewed these recent 
actions from the Fed as a way to smooth out our markets 
negative and often overly harsh a reaction to the news of a 
bank receiving a Federal grade.
    So, Mr. Baer, let me ask you this first part. What sort of 
reforms do you think are more important?
    Mr. Baer. I would--thank you, Congressman. I would agree 
with you that the qualitative portion of the CCAR should be 
part of the regular examination process just the way they 
examine anything else from credit underwriting to the markets' 
businesses. The adverse scenario is proving useful because it 
simply never binds and it has just become an exercise that does 
not have a lot of benefit and is probably not as robust as some 
of the scenarios that Dr. Holtz-Eakin was talking about that 
the bank, itself, runs.
    With respect to the results and pass or fail. I think where 
we need to get is where we have confidence that those results 
are actually meaningful and where the Fed can be comfortable 
saying there is really no way to give an exception.
    Right now, and I think you have already heard it, we are in 
a mono-scenario, mono-model world where you have extreme 
stresses in certain areas and level stresses in other. That is 
not necessarily the result that is going to--or the process 
that is going to--that is going to make the banks safest. Banks 
should not just be testing for, and I assure you they do not, 
very high increases in employment. They should be looking at 
what happens if there is a problem with foreign debt, something 
in China, something in Russia, European issue, hyperinflation, 
deflation.
    So, banks that are really managing their risk, they look at 
all those different scenarios and then they make a judgment 
about what their capital needs are. And so, we support the 
notion of the Fed running multiple scenarios, perhaps averaging 
them--averaging them over time, expressing the volatility.
    Mr. Scott. Very good. Now, Dr. Holtz-Eakin, I hope I 
pronounced your name correctly.
    Dr. Holtz-Eakin. Exactly right, sir.
    Mr. Scott. Thank you. You made some interesting comments in 
your testimony. First of all, you said that competition in the 
banking system is getting less. You said there are fewer and 
fewer banks. You said there are fewer and fewer checking 
accounts at these banks. You also said systemic risk regulation 
is now questionable.
    And then you said this. You said, we need more stress 
testing and not less. Now, we have five distinguished gentlemen 
there. How many of you agree with Mr. Eakin that we need more 
stress testing, not less? All right, we have two out of three? 
Tell me, give me--those of you--somebody--one of you who 
disagree, tell me why? Why do you think--now, Mr. Eakin has 
said why we need more. One of you that raised your hand said we 
need less. Tell me why you disagree. Yes, Mr. Fromer.
    Mr. Fromer. Yes, I will start. Let me just say that the 
issue is not the stress test, per se, because the stress test 
process is a useful process. The issue is parts of the process 
that have proven to be not transparent, whether it is the 
models, as Mr. Baer has referred to, or the economic scenarios, 
that Mr. Holtz-Eakin has referred to. So, the improvements that 
we believe are necessary are focused on the transparency of 
both of those components of the stress test.
    So, it may involve more scenarios as they have discussed. 
But I think it is the quality of the scenarios and the 
understanding of what is inside the model of the Federal 
Reserve versus the real experience of the institution itself?
    And then, the quality of the actual economic scenarios. Are 
they extreme? Are they plausibly extreme? And when do the firms 
experience that information for purposes of their capital 
planning, in order to reduce the volatility that has been 
mentioned?
    Mr. Scott. All right, very good. Thank you, Mr. Chairman.
    Chairman Luetkemeyer. Thank you. The gentleman yields back. 
With that, we go to the Ranking--or the Vice Chairman of the 
committee, Mr. Rothfus. The gentleman from Pennsylvania is 
recognized for 5 minutes.
    Mr. Rothfus. Thank you, Mr. Chairman. Mr. Baer, as you 
know, Basel III takes a fairly punitive approach to mortgage 
servicing rights compared to other intangible assets. This is 
particularly challenging for U.S. banks since our mortgage 
market relies on securitization while banks in other 
jurisdictions tend to follow the originate-and-hold model.
    Can you describe how Basel III's approach to mortgage 
servicing rights affects U.S. banks?
    Mr. Baer. Sure. Thank you, Congressman. Now, clearly, there 
was a very large change made post-crisis to mortgage servicing 
rights. The level at which a capital deduction occurred, the 
threshold was much lower. And then, the capital deduction, I 
think, rose from 100 percent to 250 percent. So, it is a 
substantial penalty.
    It is also interesting that that came out of the Basel 
Committee where, really, it is the United States. This is 
really a uniquely U.S. issue so--because we have a large 
securitization market. And I think it is fair to say that most 
countries around the world don't really have this issue as 
much. So, that may not have been the best place to have it 
debated.
    It is fair to say that during the crisis, mortgage 
servicing rights did not become a readily salable asset. So, 
clearly, there should be some restrictions on their ability to 
count toward capital. And I think it is a very good question 
whether the post-crisis reaction that came out of Basel was too 
extreme.
    And yet, I think it would be a very good idea to 
recalibrate that. And, almost certainly, downward to give more 
credit for it. Certainly not as much credit as common equity. 
But more--I think it is now five times the capital deduction 
for residential loans.
    Mr. Rothfus. Well, can you offer some insights on how 
capital rules applicable to mortgage servicing rights affect 
the consumers?
    Mr. Baer. Sure. Well, it affects consumers in two ways. 
One, it increases the cost of the servicing. But, also, what 
you have seen post-crisis, as a result of the very high capital 
charge, is that a lot of this business has migrated away from 
regulated banks to nonbank servicers.
    I think there was a time when that was considered to be a 
good thing. I think experience has taught us that consumers are 
probably better off if that is at a regulated financial 
institution with a lot of other relationships with that 
customer and a lot of incentives to do right by that customer.
    Mr. Rothfus. Mr. Fromer, over the last decade, the Federal 
banking agencies have built a complex regulatory regime with 
wide-ranging consequences for regulated industries and the 
broader economy. While our committee has led the way on 
historic regulatory reform, we should all recognize that there 
is always an opportunity to build a stronger and more efficient 
regulatory system. In order to do that, we need an honest and 
thorough account--thorough accounting of the rules in place 
today.
    In a speech earlier this year, Vice Chairman Quarles said 
the following. Quote, ``now is an eminently natural and 
expected time to step back and assess past regulatory efforts. 
It is our responsibility to ensure that they are working as 
intended and given the breadth and complexity of this new body 
of regulation, it is inevitable that we will be able to improve 
them, especially with the benefit of experience and hind 
sight.''
    Do you agree with the--do you agree that the Fed should 
undertake a holistic review of our regulatory regime and, if 
so, why would this be important?
    Mr. Fromer. Thank you for the question. First of all, I 
would wholeheartedly agree with that statement. And I believe 
it is a statement that is at least conceptually shared, not 
only here but amongst regulators outside the U.S. And that is 
to say, after you have a decade of experience in data, not only 
amongst the regulators but the firms themselves, that you--that 
the responsible thing to do here is to take a holistic 
approach.
    As perfect example of why you need to do that, we have 
something called the G-SIB surcharge that applies to the Forum 
institutions. That G-SIB surcharge is put in place for the 
purposes of putting capital into the system, in the event that 
there is a heightened risk of default or failure of a large 
firm and the impact that could have, the social cost that could 
have.
    But it was put in place at a time when a series of other 
improvements had not been implemented. Those improvements have 
been implemented. And as a consequence, the surcharge is, to 
some degree, redundant of the improvements that have been made.
    So, that is an example of the kinds of things that, I 
think, the regulators need to take a broad look at in the 
context of the framework.
    Mr. Rothfus. Mr. Noreika, in your testimony, you wrote that 
regulators should be transparent in rulemaking and supervisory 
process and not become overly reliant on unofficial rulemaking 
through guidance. Of course, this backdoor approach to 
regulation was all too common in the previous Administration.
    You recently finished a stint as the Acting Comptroller of 
the Currency. Have you seen a shift in the attitude and actions 
of regulators in recent months on this topic?
    Mr. Noreika. Well, I have, Congressman. And I think it is a 
welcomed change. And I think we are starting to see some of 
this reviewed by Congress as a congressional Review Act, such 
as we saw with the indirect auto lending guidance. And I think 
there is an effort underway at each of the banking agencies to 
catalogue their so-called guidance and see what needs to be put 
out for notice and comment. And then, also, what might be 
subject to a congressional review as well.
    So, I think it is a welcomed guidance. I think rules will 
get more rules, which will get more rules in how they are 
implemented. And guidance, obviously, is useful up to a point 
but it has to remain guidance. And when it becomes a binding 
effect, then there are certain legal protections that are there 
for the--for those that are regulated and that has to be--the 
government has to be mindful of that.
    Mr. Rothfus. My time has expired. I yield back.
    Chairman Luetkemeyer. The gentleman's time has expired. I 
call the gentleman from Texas who is recognized for 5 minutes, 
Mr. Green.
    Mr. Green. Thank you, Mr. Chairman. I thank the witnesses 
for appearing as well. I remember when we were talking about 
long-term capital. Anybody remember that name, long-term 
capital? You--OK, thank you. And we were talking about events 
and how things just couldn't happen. But before there was long-
term capital, we had people who were very skeptical about 
regulations. And nobody anticipated that long-term capital 
would occur but it did.
    I remember when the banks would not, NOT--would not lend to 
each other. And I remember why we had to resort to Dodd-Frank. 
Dodd-Frank was necessary and, in my opinion, it has served us 
well. I think the living wills, the stress tests are important. 
For a multiplicity of reasons, I might add.
    But we have two persons who have indicated that they think 
we should have more stress tests and didn't get a chance to 
hear your responses as to why. So, let me start with the first 
person who would like to respond. Which of you will that be, 
please?
    Mr. Baer. I will go. It is a very broad question. I think 
for firms that are subject to stress testing, and I think that 
should include large complex firms, those that have a variety 
of businesses perhaps internationally, you are always going to 
be better off running more stress scenarios rather than fewer. 
You don't want them only preparing for one type of impact as 
opposed to a variety. That is not to say, though, that for 
every firm, stress testing is appropriate.
    And I believe Congress got it right in 2155 when it moved 
from annual periodic with respect to regional firms. Those are, 
generally, firms that have a pretty homogenous book of mortgage 
loans, C&I (commercial and industrial) loans, generally not any 
international exposure, probably have a more complex liability 
structure.
    So, I think it really varies, depending on the bank. But 
once you are saying, yes, stress testing is appropriate for 
this bank, I am very worried about the current regime where you 
have a mono-model, mono-scenario approach to determining the 
capital adequacy of that bank.
    Mr. Green. Mr. Stanley, I think you were among the two.
    Dr. Stanley. Yes, I think what is going on here is that I 
agree, conceptually, with Dr. Holtz-Eakin and Mr. Baer that 
there are a wide variety of types of stresses and stress 
scenarios that could impact a bank. And regulators have to be--
both regulators and banks have to be creative and aggressive in 
seeking out what might be on forecast risks or risks that are 
difficult to forecast that might harm the bank.
    So,you have to test a greater range of scenarios. But I 
would just point out that this goes, in my view, completely 
opposite to this claim by industry that we can't have 
volatility in stress testing results, and stress testing 
impacts and stress tests can't change from year to year. The 
very fact that markets change so often that you have to check 
multiple scenarios, to me, means that there should be an 
unpredictable element in stress tests. They should change.
    And if you have had a stress test that was totally 
predictable, it wouldn't really be stressful and it wouldn't 
really be a test.
    Mr. Green. I think that I see someone who would like to 
respond to your response so I will yield to you. And give your 
name, if you would. Is it Mr. Baer?
    Mr. Baer. Yes.
    Mr. Green. Thank you.
    Mr. Baer. I think to the extent that markets are actually 
changing, bank's capital requirements should change. If all 
that is changing is the stress test that is chosen by the 
regulator, that really shouldn't be causing large changes in a 
bank's capital position.
    It is important because banks have to make long-term 
business plans: 1, 2, 3, 5 years out. And if you don't know 
what the capital charge is going to be for that business, it is 
very difficult to do that. And that does not help consumers or 
businesses.
    Again, if there is a real change in the bank's risk, yes, 
and it is to the upside, the bank's capital prime should go up. 
If it is--if it is to the downside, it should go down. And this 
doesn't necessarily mean, I would say to Dr. Stanley, lower 
capital requirements. To the extent that you average them, 
either averaging a variety of scenarios or averaging the 
results over a couple of years or whatever that stress scenario 
is, that would still suppress volatility. It wouldn't really 
necessarily--
    Mr. Green. I think Mr. Stanley would like to have a final 
retort so I am going to allow this debate to continue for this 
last round. Mr. Stanley.
    Dr. Stanley. Well, I have very little time but I guess I 
would just point out that we--in terms of capital planning and 
long-term planning, we actually don't want banks over-adjusting 
and trying to track the regulatory capital requirements. We--
that element of unpredictability, I think, could be important, 
precisely so that banks don't take excessive account of 
regulatory requirements in their future planning, and instead 
look more at the business environment.
    Mr. Green. Mr. Chairman, if I may, Ranking Member Clay has 
asked that I offer some materials for the record with unanimous 
consent.
    Chairman Luetkemeyer. Without objection.
    Mr. Green. The Center for American Progress has a rather 
lengthy document and letter to be submitted; Better Markets 
similarly situated; the Americans for Financial Reform. I ask 
that, if there are no objections, that all be submitted into 
the record.
    Chairman Luetkemeyer. Without objection.
    Mr. Green. Thank you.
    Chairman Luetkemeyer. The gentleman's time has expired. 
Now, we go to the gentleman from Oklahoma. Mr. Lucas is 
recognized for 5 minutes.
    Mr. Lucas. Thank you, Mr. Chairman. And I would like to 
revisit a couple of issues with my colleagues here. But first, 
I always remind folks that coming from a capital-starved 
region, the oil and gas industry, agriculture, Main Street in 
rural Oklahoma, capital is always a challenge for us. By the 
same token, I acknowledge to you that I come from a long line 
of debtors, so I have a certain perspective from that 
perspective.
    Let us visit Mr. Baer. I have heard my constituents, in the 
wake of S2155, say that they are confused about legislative 
intent when it comes to stress testing. Some of my banks, most 
of which are very small and are well under the $100 billion 
threshold, believe that 2155 was meant to do away with all 
stress tests for banks under those numbers, not just the test 
called for in Dodd-Frank. I realize you don't speak for FDIC, 
but is this a view that is widely shared by--among the 
industry?
    Mr. Baer. Yes. I think, Congressman, that if you are under 
that threshold, it is the assumption and the only way I would 
read the statute is that that is the end of having to do these 
types of stress tests. And I would say we are actually quite 
concerned that regulators these days are very fond of what we 
call horizontal reviews, which we sometimes call examinations 
management consulting, where they will look at a variety of 
banks and come in and say, you know what? We don't like your 
practices. We want you to do what some other banks are doing.
    So, to the--we are very concerned that these same 
requirements that have been ended by 2155 will actually come 
back in through the examination process. And I really think 
that is something for this committee to keep an eye on.
    Mr. Lucas. That was my next question: How we clarify the 
situation so that the intent behind 2155 is obvious to 
everyone.
    Mr. Baer. Again, Congressman, I think it is a real concern. 
We have a whole--we could have a whole separate hearing on the 
examinations as far as the regulatory process. Because I think, 
particularly for smaller banks, a lot of this isn't about 
stress testing or G-SIB surcharges or any of that. It is really 
about a fundamental shift, post-crisis, away from examinations 
focusing on safety and soundness issues that are material to 
the health of the firm and toward more minor criticisms and 
consulting and horizontal reviews.
    I do think it is going to be a long process. But I hope 
that the new leadership of the agencies can refocus the exam 
teams on matters that are material to the financial institution 
and not just wanting them to do it a different way.
    Mr. Lucas. So, you don't disagree. When the bankers say 
they read what they read which is how I read the bill. It 
sounds like the way you read the bill.
    Mr. Baer. Yes, that is what I understand. I think Mr. 
Noreika eluded to guidance where, for years now, banking 
agencies have been issuing guidance. And they say it is only 
guidance but every banker you talk to, every compliance 
department says, no, we treat that as a binding regulation in 
every case because that is the way the examiners treat it. So, 
it is a cultural thing. I think it is going to be difficult to 
resolve but it is an important issue.
    Mr. Lucas. Mr. Noreika, let us touch on that subject of the 
issue of mortgage servicing rights and the treatments under the 
capital rules. I have a couple of constituent institutions in 
Oklahoma that have been very successful in servicing things 
like FHA loans. There other institutions across the country 
that are very successful in dealing with V.A. and USDA loans.
    And they are very concerned, as we have discussed earlier, 
that under the Basel III cap, combining with the risk of these 
assets hinders their ability to engage in the activity, and 
they tell me that they are seeing literally the business being 
driven to nonbank lenders where their regulation is lighter.
    Could you touch on that for just a moment? Is this a 
legitimate concern by my constituents?
    Mr. Noreika. Yes. And it is something that I faced at the 
OCC and we put out a proposed rule that hasn't yet been 
finalized. But certainly the capital charges for servicing 
rights are overly punitive. It disproportionally impacts 
regional community banks and reduces the availability of loans 
in our communities. Holding mortgage servicing rights is often 
part of a sound strategy for banks that originate and sell 
loans while retaining the right to service these loans.
    The practice permits banks to make loans in our community 
and develop stronger customer relationships while appropriately 
managing risks to their balance sheets.
    As I mentioned, when I was at the OCC, we put out a capital 
rule to streamline and loosen the punitive requirements on 
these requirements in, I believe, September 2017. I think the 
time has come for the agencies to finalize that rule, with 
respect to mortgage servicing rights, and take away some of the 
punitive effects that comes from holding these assets.
    Mr. Lucas. Thank you, sir. I yield back, Mr. Chairman.
    Chairman Luetkemeyer. The gentleman yields back. With that, 
we go to the distinguished gentleman from Kentucky, Mr. Barr. 
The Chairman of the Monetary Policy Committee is recognized for 
5 minutes.
    Mr. Barr. Thank you, Mr. Chairman. I will start with Dr. 
Holtz-Eakin. The question about the legislation that was 
recently signed into law, Economic Growth, Regulatory Relief, 
and Consumer Protection Act. What do you believe will be some 
of the most pronounced impacts on bank lending, now that that 
law has been signed?
    Dr. Holtz-Eakin. I think the most pronounced impacts are 
going to be in the relatively small loans: $50,000, $100,000, 
$200,000 to small businesses in the area--in those areas. We 
know there has been a big geographic dispersion in the quality 
of the economic recovery. It looks a lot like the geographic 
dispersion in the access to credit. And so, I think that is an 
important economic benefit.
    Mr. Barr. Can you elaborate a little bit more on your 
testimony about market discipline as an additional factor in 
strengthening the financial system, in addition to capital 
requirements?
    Dr. Holtz-Eakin. There is nothing better than capital for 
honing incentives, right? The thought of losing your own money 
is a powerful motivator. And if you have investors who are 
looking at institutions carefully and correctly trying to price 
the risks that those institutions face, that is a tremendous 
source of discipline to the operation of those institutions.
    So, wherever possible, it is useful to try to bring that 
into the process. And that is one of the reasons I, at least, 
think that the stress tests are so valuable. They provide 
information to market participants about how firms react in 
different situations. That is useful for pricing.
    Mr. Barr. Is there a lack of transparency anywhere in the 
law right now that could be corrected, in terms of transmitting 
greater levels of information to consumers?
    Dr. Holtz-Eakin. I just echo a lot of the things that Mr. 
Baer said about the current stress testing regime not having 
sufficient robustness to convey all of the risks that these 
institutions will face and can weather or not weather. And that 
is what you want to know.
    Mr. Barr. Mr. Noreika, thank you for your service at the 
OCC. And let me just ask you, now given your background in both 
the private sector and the public sector, your thoughts about 
the role and importance of regional banks in the traditional 
lending model and how does over-regulation contribute to 
curtailing lending in economic growth?
    Mr. Noreika. Well, thank you, Representative Barr. Look, 
failing to properly tailor the enhanced prudential 
requirements, with respect to regional banks or all banks, will 
continue to increase the price and limit the availability of 
credit in the United States and, ultimately, stifle economic 
growth. Poorly tailored requirements also hurt access to 
credit, usually for those at the margin, those in underserved 
communities which are often served by regional banks. Poorly 
calibrated requirements also unintentionally incentivize 
unnatural and risky behavior and they make the market less 
safe.
    Mr. Barr. Can I jump in really quickly?
    Mr. Noreika. Yes.
    Mr. Barr. Your--the thrust of your testimony was that the 
$50 billion asset threshold was an arbitrary threshold.
    Mr. Noreika. Yes.
    Mr. Barr. And that the new regime is a preferred approach, 
based on these multi-factor tests.
    Mr. Noreika. Yes.
    Mr. Barr. The presumption is that if a--if an institution 
has assets less than $250 billion, it is--it doesn't warrant 
that enhanced prudential supervision. But it does give 
discretion above 100 billion for that--for the application of 
those enhanced supervisory rules.
    What is so--what is magic about the $250 billion threshold? 
Is there an argument to be made that that threshold should go 
up as long as the regulators have the discretion to apply a 
similar multi-factor test to institutions between, say, 250 or 
500 billion or, for that matter, any institution that is not 
categorized as a G-SIB.
    Mr. Noreika. Sure. That is a very good question. Look, I 
think the way the world is divided now, in light of the 
regulatory relief legislation, is that everything under 250 
billion is presumed to be out. And everything under 100 billion 
is absolutely out by statute.
    Above 250 billion, Congress now has required, directed the 
Federal Reserve to apply its enhanced prudential standards 
based on this multi-par test. One of those factors is asset 
size. But the other factors are not asset size. And so, even 
for the banks above $250 billion, the Federal Reserve has to go 
back and they have to look at each of their--and it says any 
prudential standard so it is for each one. They have to look at 
them and they have to look at the--those factors with respect 
to the individual institution.
    And I think this dovetails nicely with what we are hearing 
out of the new leadership of the Federal Reserve as far as 
tailoring goes. Congress has provided a roadmap for tailoring.
    Mr. Barr. I have more questions but my time has expired. 
Thank you.
    Mr. Noreika. Thank you.
    Chairman Luetkemeyer. The gentleman's time has expired. 
With that, we will go to Mr. Tipton. He is from Colorado. He is 
recognized for 5 minutes.
    Mr. Tipton. Thank you, Mr. Chairman. I thank the panel for 
taking time to be able to be here. And Mr. Noreika, maybe you 
would like to go back a little bit more, in terms of some of 
the questions that Mr. Rothfus had brought up, in regards to, 
are we actually seeing the needle move after 2155 is being 
signed into law with the regulators. Some of the comments that 
I have had from some of my local banks is when--you were just 
talking about some of the tailoring end of it.
    Mr. Noreika. Right.
    Mr. Tipton. They said they really haven't seen any real 
impact. It is business as usual. So, could you drill down a 
little bit more in where you are seeing that movement starting 
to go?
    Mr. Noreika. Sure. And, look, I am on the outside looking 
in now. And I was recently on the inside looking out. I don't 
disagree with your statement. I think that Congress has 
provided fairly clear guidance to the agencies.
    I think that the agencies did take immediate steps for the 
banks below $100 billion to inform them of certain changes. 
Maybe that hasn't filtered out entirely. But I think that 
whatever those are, they should be in constant contact with 
their regulator to work out those issues because what Congress 
did was fairly clear.
    I think the real issues immediately facing the agencies are 
with below 250 billion, this presumption that they are out, 
unless there is a finding made that there is a threat to 
financial stability or safety and soundness and the application 
of a multi-par test. And then, above 250 billion, there is the 
application of the statutory multi-par test that now is 
directed by statute. And I think that is one we haven't yet 
seen the agencies come out and talk about. And hopefully we 
will soon.
    But I do have an appreciation for the way things work in 
the public sector as opposed to the private sector. I suppose 2 
months in the private sector--in the public sector isn't quite 
as fast as perhaps I would like. But--or you would like.
    But I am sure they are working on it diligently. And I 
think hearings like this help give valuable input on helping 
them to come to a formulation of how they are going to deal 
with these different groups of banks.
    Mr. Tipton. Right. And I think Mr. Barr's comments in terms 
of setting arbitrary thresholds and how that impacts. Do you 
have some recommendations specifically rather than just having 
arbitrary thresholds? I know they are working on it. But is 
there something more that Congress could be doing?
    Mr. Noreika. Well, look, I think you are doing exactly the 
right thing like holding hearings like this. And I think you 
can step in with targeted legislative actions if the agencies 
go in the wrong direction or read the law the wrong way. Hold 
their feet to the fire. And that is exactly what you should be 
doing.
    I think right now, the goal is for the agencies, and with 
congressional direction, to go reexamine everything they did 
before. And so that not only is the scope, but also the 
substance as well.
    I think you have to also look at each of the requirements 
and see whether they are narrowly tailored or whether it is a 
broad-brush approach to applying something to one of the 
largest banks, then being falling downhill, if you will, as I 
think Senator Corker once told me toward the Main Street banks 
and having an overly punitive effect which has ramifications 
for the economy.
    Mr. Tipton. Mr. Baer, would you like to comment a little 
bit on this? And I thought it was interesting, you were making 
the comment regards to some of the horizontal type of 
examinations that are going on. And I came from the private 
sector and we were constantly doing a review in business, 
almost every day, had the flexibility, the nimbleness to be 
able to make some changes, if necessary to be able to do it.
    Would you address some of that regulatory process?
    Mr. Baer. Sure, Congressman. It is actually quite--I think, 
quite interesting, from a bank regulatory policy perspective. 
That clearly, and I think they would agree post--in recent 
years, the Fed and the OCC are going in opposite directions, in 
terms of how they examine. The OCC is reemphasizing the 
importance of the examiner in charge and having a resident team 
that knows and understands that bank.
    The Federal Reserve is moving toward a more centralized 
approach with cross-reserve bank, cross-functional teams and a 
lot of folks in Washington. I could actually make a good 
argument for or against either approach. I think either could 
work, either could fail.
    But I do think the risk of the latter approach is that you 
get to having the cross-functional team as, sort of, judge and 
jury. Where they are looking at multiple banks and they are 
picking the one they like the best.
    I have heard this from multiple firms that they were told, 
well, yes, on the liquidity front, you are in compliance with 
the OCR. You passed CLAR. Your own work is pretty good. But we 
just completed a horizontal review, and we like what somebody 
else is doing better.
    Will we give you access to that? No, we will not. That is 
confidential supervisory information. But we would like you to 
up this or change this. And I think that is very unfair to the 
banks and also I just think it is a bad idea.
    There are real benefits--ultimately, banks compete on the 
ability to manage risk. And if you can have all banks manage 
risk the same, obviously that is something of an overstatement. 
But to the extent that you are pushing back some to measure 
risk the same way and manage it the same way, that is not a 
great thing.
    Mr. Tipton. Thank you. My time has expired, Mr. Chairman.
    Chairman Luetkemeyer. The gentleman's time has expired. 
With that, we have the Ranking Member has returned. And with 
that, we recognize him for 5 minutes' worth of questions. Mr. 
Clay.
    Mr. Clay. Thank you, Mr. Chairman. And Dr. Stanley, 
regulators under the Trump Administration have said that since 
it has been a decade since the financial crisis, and it is time 
to review and revisit all of the post-crisis financial rules to 
seek improvements, what is your early assessment of their 
proposals? Are their proposed modifications to post-crisis 
reforms one-sided with the focus on deregulating the financial 
industry?
    Dr. Stanley. Well, you answered the question for me. They 
absolutely are one-sided. And we have no problem with 
reviewing. We do believe that it is entirely appropriate to 
review our regulatory framework.
    But this is a review that seems exclusively focused on 
weakening the regulations that came out of the financial 
crisis. And, in fact, in several cases, we had proposed rules 
that were ready to go, that would have strengthened regulation, 
regulation of bonus--bank bonuses, regulation of commodity 
activities at banks. And these rules were just dropped as 
though they never existed because they didn't go in that 
deregulatory direction.
    Mr. Clay. Yes. And do you think lessons from the financial 
crisis have faded in the minds of some policymakers? I know 
that when I look at the housing market, just like African-
American borrowers were steered into high-priced loans for no 
reason other than the complexion of their skin, that now we 
have reverted back to that. That there is still a 
disproportionment--disproportionate number of people who are 
applying for 30-year mortgages that are being denied. Do you 
think those memories have faded already after 10 years?
    Mr. Stanley. Well, I think that memories may have faded in 
Washington D.C. I don't think that memories have faded outside 
of Washington D.C. Middle-class wealth is still significantly 
lower than it was before the financial crisis. Are the impacts 
of financial crisis, in terms of loss of housing, in terms of 
increases in poverty have not really--are still with us outside 
of Washington D.C.
    Mr. Clay. Yes. Do you believe the Fed failed, as many of us 
do, at implementing and enforcing our consumer financial 
protections lost prior to the creation of the CFPB (Consumer 
Financial Protection Bureau)?
    Dr. Stanley. Well, I think it is very clear that the Fed 
failed. The Fed was warned and the Fed did not take action on 
predatory subprime lending, on predatory lending that targeted 
minority communities. And in the case of the OCC, we had the 
OCC actively stepping in to preempt and reverse State laws that 
would have taken action against some of this predatory lending.
    So, they were actually weighing in to expand predatory 
lending. And that is why it has been so important to create an 
independent consumer agency.
    Mr. Clay. And then, they knew the Countrywides and the 
other predators were out there preying on consumers and they 
enhanced it and helped them. Unbelievable.
    Was it important to impose enhanced prudential standards on 
the Nation's largest banks as Dodd-Frank did, including 
requiring more capital, less leverage and regular stress tests?
    Dr. Stanley. Well, I--absolutely. Things went terribly 
wrong before the financial crisis. You had entities, weeks 
before they failed, reporting that they were perfectly fine and 
they exceeded regulatory capital requirements that existed 
before the financial--before 2008, weeks before they failed.
    So, the prudential requirements before 2008 were just 
manifestly inadequate and permitted all kinds of abuses and 
really had to be reformed.
    Mr. Clay. Do you support the Volcker Rule's prohibition on 
proprietary trading so that banks that benefit from the 
Federal's safety net do not gamble with deposits?
    Dr. Stanley. Yes, we do. And a lot of people say that the 
Volcker Rule proprietary trading ban is somehow disconnected to 
the crisis. But the truth is that banks lost hundreds of 
billions of dollars from assets held in their trading books, 
firm trading inventories. They lost well over $100 billion in 
2008 and that was a major contributor to the financial crisis.
    And Volcker, I think, could be improved in a variety of 
ways but it takes that on and that is a critical issue.
    Mr. Clay. All right, thank you for your responses. And, Mr. 
Chairman, my time is up.
    Chairman Luetkemeyer. The gentleman's time is up. With 
that, we have a second round. Mr. Barr would like to ask a few 
additional questions. He is recognized for 5 minutes.
    Mr. Barr. Thank you. And I appreciate the second round, Mr. 
Chairman. And to Mr. Fromer or Mr. Baer. The question is about 
this mono-model of stress testing. And I think, Mr. Baer, you 
specifically touched on this. I am interested in this because I 
have heard Randy Quarles talk about this as a risk for 
regulators to focus on a mono-model testing.
    And I am curious to know your thoughts on how the Fed and 
other regulators can avoid--best avoid a mono-model stress 
testing regime. And how can we avoid a situation where banks 
and participants in the financial services sector are moving in 
the same direction, creating and concentrating risk, as opposed 
to allowing an organic diversification of risk that is--that is 
fueled by a diversity of stress testing scenarios?
    Mr. Baer. Sure. You may--I think one potential answer is to 
provide full transparency around the model which would also 
allow for notice and comment, from a whole wide range of folks 
all on this panel, about whether that is a good model or not. 
It would allow backtesting and real consideration of it. I know 
there have been concerns expressed by some that that would let 
the banks know the test.
    But, I think of an analogy of, if the EPA decided to 
regulate pollution controls and said, we are not going to tell 
you the regulation. We are just going to run the secret model, 
and, at the end of the year, we are going to tell you whether 
you passed or not. And if you didn't pass, then you can't 
operate next year. No one would think that that is a fair 
system. When the government has rules, we, as citizens, have 
the right to know the rules.
    Now, if the concern is so great, though, that we aren't 
allowed to know the test, then I think it is a perfectly good 
option to allow bank models to be used as part of the stress 
test. Those models are not made up. They are rigorously 
backtested.
    And the Federal Reserve now reviews and approves every one 
of those models. So, if they can't provide transparency, then I 
think there is a ready alternative.
    Mr. Barr. Right. So, I think it is purposeful from the 
standpoint from financial stability. It is also a due process 
issue, of course.
    Mr. Fromer, let me just shift gears, actually, to another 
question. In recent testimony before this committee, Randy 
Quarles, Vice Chairman of Supervision, testified that because 
of the improvement in the resolvability of firms realized over 
the past few years through the living will process, it is 
appropriate now to assess--to reassess the G-SIB surcharge 
calculation.
    The G-SIB surcharge applied to U.S. banks has nearly 
doubled that of the international standard, placing our 
institutions at a competitive disadvantage in the global 
marketplace. But now, we hear about this stress capital buffer 
that, effectively, doubles down on what has already been 
acknowledged to be a miscalibrated requirement by enshrining 
the G-SIB surcharge in this new rule.
    I know you share the same concern. Can you elaborate on why 
that is a problem from a--from the standpoint of international 
competitiveness?
    Mr. Fromer. Sure. First of all, the G-SIB surcharge, as I 
stated earlier, was put in place to deal with the systemic 
risk, potential for a default, the impact of default in the 
system. As Governor Quarles and others have indicated, there 
are a number of other steps that took place after the 
implementation of the G-SIB surcharge of the establishment 
which, to some degree, have made the G-SIB surcharge redundant. 
And that is why we believe it is necessary--it is crucial, in 
fact--to go back and look at it.
    The problem with the G-SIB surcharge is with respect to 
international competitiveness. It has to do with the fact that, 
in the United States, the regulators applied a higher standard, 
known as method two. And method two is, essentially, a higher 
charge for these U.S. G-SIBs.
    In our view, that actually creates a built-in disadvantage 
for U.S. institutions vis aAE1 vis their foreign peers. First 
of all, if you feel like the--if you believe that the system 
has improved through a variety of different improvements, 
whether it is TLAC or clearing and margin or living wills, you 
should go back and look at the G-SIB surcharge. And then, 
specifically you need to look at method two because of the 
built-in disadvantages it provides for the U.S. G-SIBs versus 
their foreign peers.
    And it is amplified, as I think you are getting to, by the 
fact that the G-SIB surcharge now has been imported into two 
other schemes, one of which is the supplementary leverage ratio 
for the largest banks, and the second is the stress capital 
buffer proposal.
    Mr. Barr. And so, I think we all should be interested in 
the competitiveness of U.S. institutions, relative to the--to 
our foreign competitors. And, yet, at the same time, to Mr. 
Noreika's testimony, we also know that foreign banks are an 
indispensable conduit for foreign investment in the United 
States, which is a source of a lot of high-paying jobs. 
Frankly, higher foreign direct investments is responsible for 
higher paying jobs, in many cases, than domestically produced 
jobs.
    My question to you is, according to a 2016 Federal Reserve 
report, a substantial percentage of loans provided in the--in--
my time may have expired already. Well, I didn't get to that 
question but we will continue the discussion, Mr. Noreika, at 
another time. Thanks.
    Mr. Noreika. Happy to.
    Chairman Luetkemeyer. The gentleman from Kentucky is full 
of questions. So, we can be here until midnight, and he will 
still be asking questions. But good questions.
    The Ranking Member, Mr. Clay, has some second questions as 
well and he is recognized for 5 minutes.
    Mr. Clay. Thank you, Mr. Chairman. And, Mr. Noreika, during 
your tenure as Acting Comptroller of the Currency, you moved to 
weaken the agency's examination policy for the Community 
Reinvestment Act (CRA) with respect to discriminatory or other 
illegal credit practices. Can you explain to the committee how 
this policy helps combat discriminatory lending?
    Mr. Noreika. Well, first of all, no, I didn't. Second, what 
I did do was we instituted guidance that put the Community 
Reinvestment Act back in--
    Mr. Clay. Hope that is not an omen--
    Mr. Noreika. Hopefully it is not for one or the other of 
us, right? Exactly. So, what I did do was reinstituted a policy 
so that, basically, community reinvestment is evaluated for 
community reinvestment purposes. So, there had been a trend in 
the prior Administration toward penalizing banks for things 
that had nothing to do with investment in their communities and 
the type of lending activities that they used to claim credit 
for their CRA exams.
    And so, what we did was we went back to basics of the 
Community Reinvestment Act. So, at the outset, each bank is 
reviewed, under the current rule at least, for its lending 
operations, its service activities, and its investment 
activities.
    And what we did is we said, with respect to the activities 
for which a bank claims lending credit, if those activities are 
done in a way that harms consumers, then that will be the basis 
for a downgrade. There has to be a logical nexus for the 
noncompliant consumer-harming activities to affect the CRA 
rating. Because, again, CRA, the whole purpose of it is to make 
sure banks are lending in their communities.
    We don't want to be overly punitive because then a bank 
might decide, hey, we have such big problems. We are not going 
to do anything. We are going to get our problems settled and 
not invest in the communities. I did not want that to happen.
    And what I worried about was that the so-called downgrades, 
which expanded more broadly than the activities that were used 
to claim credit, would actually act as a deterrent to 
investment on communities.
    Mr. Clay. And thank you for that response but I was--I am 
wondering, did you dig into the numbers to see that, OK, in 
economically disadvantaged parts of that service area, did they 
do 30-year mortgages? Did they expand 30-year mortgages? Did 
they do home improvement loans? Did they do small business 
loans? And did that data help you determine the grade?
    Mr. Noreika. Well, look, I think you can never decide 
something going forward. Obviously, afterwards, you have to 
look back and see how it did. And I think that is the general 
context of this entire hearing is looking back at things that 
may have been perfectly reasonably put in place at the time but 
may have a deleterious effect or just the market changes over 
time.
    With respect to Community Reinvestment Act. Look, I think 
the original purposes of the Act were, again, clearly to get 
banks to not abandon their local communities. A very laudable 
effect. I think the worry was that a lot of other baggage was 
getting placed on that that, ultimately, would deter lending in 
communities.
    And that is what, frankly, concerned me the most in why I 
instituted that examination guidance was to, again, get back to 
the basics and encourage banks to lend in their community and 
not deter them from doing that.
    Mr. Clay. But think about the challenges that impact 
economically disparate communities, economically disadvantaged 
communities. Those are the ones that need the financial 
stimulus the most.
    Mr. Noreika. Oh, I absolutely agree with you.
    Mr. Clay. And so, I mean, that is what--
    Mr. Noreika. I absolutely--
    Mr. Clay. I always thought the CRA was.
    Mr. Noreika. No, I absolutely agree with you. And I do 
somewhat worry CRA was getting highjacked as just another way 
to penalize banks for general things they did wrong to 
consumers. And I think there has to be that absolute laser 
focus of CRA on the underserved communities, themselves, and 
getting banks to invest in them. And that was why I did what I 
did.
    Mr. Clay. And that is why we have the CFPB as to be the cop 
on the beat, I would think. Thank you. I yield back.
    Chairman Luetkemeyer. The gentleman's time has expired. 
With that, we have the gentleman from Georgia. Mr. Loudermilk 
has returned and he is recognized for 5 minutes.
    Mr. Loudermilk. Thank you, Mr. Chairman. And I would like 
to start off by yielding a portion of my time to my friend from 
Kentucky, Mr. Barr, so he can continue that very intriguing and 
interesting line of questioning that he was--
    Mr. Noreika. You are not going to get me out of the 
question here are you?
    Mr. Barr. I want to thank my friend. And I will be brief 
since I have already consumed too much time.
    But to follow up to Mr. Noreika. Just as the G-SIB 
surcharge could put U.S. banks at a competitive disadvantage, 
what I was getting at in my question was that, similarly, 
unfair treatment of U.S. subsidiaries of foreign banks could 
also be a problem, from the standpoint of U.S. economic growth. 
Because it could in--could incentivize those foreign banks to 
decrease their U.S. operations and could lead to a withdraw of 
foreign funds. Many of which are contributing to foreign direct 
investments which, again, is a source of a lot of jobs and 
economic growth.
    So, the question is, from a competitive equity standpoint, 
how can we approach regulations to make sure that U.S. 
subsidiaries of foreign banks operate on a level playing field 
with our counterparts?
    Mr. Noreika. Sure. And that is the statutory directive. But 
I must say, from my time in office, having seen these foreign 
banking organizations come talk to me, they were dramatically 
pulling outside--out of the United States, especially with 
respect to the capital markets' type activities. That before 
the intermediate holding company requirement had been the 
subject of functional regulation under the Gramm-Leach-Bliley 
Act. Due to the international--intermediate holding company act 
had been pulled into banking regulation and subject to these 
enhanced prudential standards. The cost of doing business 
apparently went through the roof and drove that capital outside 
the United States.
    And I think, to the detriment of our country, as you are 
pointing out, in the sense of the markets are less liquid, the 
activity is pushed out into less-regulated spheres. And, 
obviously, there is the real-world impact on people who may be 
employed or not employed anymore by these institutions.
    Mr. Barr. And I better reclaim Mr. Loudermilk's time. Thank 
you, my friend.
    Mr. Loudermilk. All right, thank you. And, Mr. Noreika, we 
will continue with you since we have you there. My question 
really is around the SIFI (systemically important financial 
institution) designation. And under Dodd-Frank, it specified 
between $100 and $250 billion in assets. Those financial 
institutions are entitled to complete relief from regulation as 
a SIFI institution after an 18-month transition period.
    My understanding is, also, that after that period, that the 
law gives the Fed the ability to restore the regulations if the 
bank becomes a systematic risk. But under the current 
conditions, the recent CCAR results and G-SIB surcharge risk 
data shows that banks with less than 250 billion in assets do 
not present this type of risk. I, as well as others, think they 
should be exempt from all the regulations associated with being 
SIFI unless there is significant change to risk profile.
    My question is, do you agree that these banks do not 
currently pose that type of systemic risk?
    Mr. Noreika. I do, Congressman. Certainly, if those are the 
Fed's own findings, with respect to systemic risk, I don't 
think there is any reason to wait to exempt them from the 
enhanced prudential standards while the Fed then goes and 
reviews how the standards need to be revised in light of the 
new law.
    Mr. Loudermilk. OK, thank you. Mr. Baer, with the short 
time that I have remaining. I understand that some of the 
biggest challenges of the CCAR stress test, in addition to the 
sheer burden of these Dodd-Frank requirements, is the fact that 
the stress test models used by the Fed are relatively secret. 
In a 2016 GAO report, it showed that CCAR process is overly 
qualitative, offered too little communication for regulated 
banks, and that the scenarios were designed without appropriate 
analysis. Can you shed light on why that is such a problem for 
institutions such as yours?
    Mr. Baer. Sure. It is difficult even to explain how 
complicated the CCAR process has become. What a data drain it 
is. What a resource drain. I think even for banks in the 100 to 
250 billion who we expect to no longer be doing this, there are 
probably dozens of people, maybe up to 100 at the bank doing 
this full time. At the larger institutions, it is hundreds of 
people doing this full time. It is a very intensive data 
exercise.
    And then, of course, as I got to earlier, they really don't 
know a lot about the model that they are trying to manage to 
them. You can try to reverse engineer some things and we have 
actually tried to derive the implicit risk weights from what 
that model produces. And you can get some indications.
    But it is a very difficult process. Again, I do support 
stress testing for large complex institutions that have really 
complex risks. But, particularly for a $100 to $250 billion 
institution, we have traditional supervision. Without that, it 
is unnecessary, I believe.
    Mr. Loudermilk. Thank you. With that, I yield back.
    Chairman Luetkemeyer. If you have some additional 
questions, gentlemen, you can be certainly recognized because 
we have a little time here.
    Mr. Loudermilk. In other words, I am the only one left, Mr. 
Chairman, is that right?
    Chairman Luetkemeyer. It is raining outside and the game 
hasn't started yet tonight so we are OK with it.
    Mr. Loudermilk. Well, I think with the last thunder clap, 
everybody ran. I don't--I hope they are not going two by two to 
a big wooden boat somewhere. Maybe we should--
    Well, then, I do have--I will also defer to Mr. Fromer to 
answer the same question if you would like.
    Mr. Fromer. I think what I will add to what Mr. Baer said 
was that for banks of all sizes, it is a difficult process. It 
is a complex process. It is resource consumptive. But the other 
thing is that it makes it extraordinarily difficult for the 
boards and the management of these institutions to go through 
this thoughtful process of planning the deployment and the 
distribution of their capital.
    And to the extent that you have opacity in the models, and 
to the extent that you get scenarios presented to you in 
February for a process that is supposed to conclude and does 
conclude in June, and then you live with the results for the 
next quarters and have no flexibility in terms of your further 
distribution of capital. Even though there may be things going 
on in your firm or things going on in the economy at large 
which affect the operation of your firm, affect the plans that 
you have made and your ability to dynamically change the nature 
of your business with those events.
    The process right now is very constraining. And, in effect, 
it says, even though you have met your minimum requirements, 
even though your institution is safe and sound, you have all 
your minimum requirements in place, you as a board, you as a 
management are still restricted, in terms of the way you can 
deploy and distribute your capital.
    And that is sort of an erosion of fiduciary responsibility 
that we think needs to be addressed as part of the overall 
review.
    Mr. Loudermilk. So, does this inhibit your ability to 
properly serve your customers?
    Mr. Fromer. Inevitably, it does. If you have gone through a 
thoughtful planning process, as our institutions all do, and 
you are constrained by information that you do not have, 
because you just don't have access to it. None of us can sit 
here and tell you what goes on, with respect to these models 
and how the scenarios are actually put together. Because it is 
opaque.
    So, the degree that you can't make decisions about the 
operation of your institutions, it inevitably affects the kinds 
of services that you are going to provide to your customers and 
the pricing as well.
    Mr. Loudermilk. And Mr. Baer?
    Mr. Baer. If I could just say, there is also a really 
important credit allocation component to this. We did--our 
research team went back and looked and derived the implicit 
risk weights for CCAR compared to the standardized approach and 
then compared to the bank's own modeled approach through DFAS. 
And what they showed was that the implicit risk weights, that 
is the capital charge, were dramatically higher for certain 
asset classes. Most notably, small business, prime mortgage, 
and market making.
    It is actually about the same for C&I. But, so, implicitly 
in this, though, is that it is driving banks in certain 
directions and driving all the banks in the same directions. 
And it is interesting, we, then, took the next step and said, 
well, can we see that in the actual data in how banks behave?
    And what you know, if you look, and I think some of this is 
in my testimony, which I know some of this is in my testimony, 
if you compare banks subject to CCAR banks versus banks not 
subject to CCAR, and look at their behavior, you will see the 
banks that are subject to the test are moving out of the asset 
classes that are most affected by the test.
    Mr. Loudermilk. OK, thank you. Mr. Chairman, I don't have 
any further questions. I could--be glad to yield to you or I 
yield back.
    Chairman Luetkemeyer. We are already on our second round, 
so you get your second round of questions. So, if you are done, 
well, we will move on.
    Mr. Loudermilk. I am done.
    Chairman Luetkemeyer. The gentleman yields back. OK. I have 
just one comment which is, the reason for the stress test, 
originally because of Dodd-Frank, was because of the 
systemically important institutions that could bring down the 
economy.
    And I think we have talked about in the bill that--2155 
that set thresholds. And while I am not a big fan of 
thresholds, I think anybody would recognize that $250 billion 
bank, while that is a big bank, it is not big enough to bring 
down the economy of the United States.
    And so, I think you have to remember why that part of Dodd-
Frank is there and why--what kind of implications it could have 
and should have. And most banks now that are exempt under 250, 
I--we have--I guess we will watch the actions of the Fed. But I 
know the regulators. But we--they should not be considered 
systemically important the part where they are going to be 
negatively impacted by overburdenedsome regulations of 
additional tests.
    One thing we haven't talked about yet, we have discussed 
pretty thoroughly everything else, is--and, Mr. Baer, I think 
you brought this up, is CECL. Can you comment, and Mr. Fromer 
perhaps as well, with regards to the impact of CECL loan 
capital accounts and if you have seen any kind of impact at 
this point yet.
    Mr. Baer. Certainly. Thank you, Congressman. I think it is 
a terrifically important issue, and I appreciate the 
opportunity. I think CECL began with a very good idea. The 
Financial Stability Board recommended to the Fed that they look 
at the accounting for reserves. The concern was that reserving 
can be quite cyclical. That is in the midst of a crisis, banks 
are having to add reserves. And that means they are shrinking 
lending.
    A fundamental mistake, though, I think was made in 
projecting what the effect of this would be. The change was 
made from the incurred loss methodology which basically said, 
you set up your reserve when loss is estimable and probable. 
That has been the standard for 40 years. The new requirement 
says that you have to set up a reserve at the time you make the 
loan for all projected losses over the life of the loan, even 
if the chances of those are small.
    Meanwhile, you cannot book any potential income from that 
loan over the course of the loan--of its life. So, that is a 
fairly significant change. But the idea was, OK, well, let us 
have them take the reserve at the beginning. And then, when 
things go bad, they won't have to restrict and build a big 
reserve.
    The fundamental problem with that, though, is it presumed 
and, I think, the analysis done by economists on it, presumed, 
as economists like to presume, perfect knowledge. So, they 
presumed that everybody got it right at the start.
    What our team did, after hearing a lot of nervousness from 
the CFOs about this, is we actually went back and we ran the 
2007 to 2009 financial crisis. And we said, let us not presume 
perfect knowledge. Let us actually look at what the 
macroforecasts actually were at the time. Stand in the economic 
community and see what happened.
    And what happened was they didn't have the perfect 
knowledge. And what happened is you got into 2008. That is when 
all the forecasts went bad or assumed that there was going to 
be a very large recession.
    And so, what would have happened if CECL had been in place 
is there would have been massive reserves taken. Not just 
reserves on the loans for which losses were already estimable 
and probable. But loans for every need, a reserve for all 
loans. And particularly for loans for low- to moderate-income 
people.
    So, what our review shows is if CECL had been in place, it 
would not have been countercyclical, it was not of built 
reserves in 2006 and 2007. It would have been profoundly 
procyclical and would have met massive bank reserves in 2008, 
which almost certainly would have dramatically heightened the 
recession. So ours shouldn't be the last word on this.
    And we are trying to encourage more research, not 
discourage more research. But it is certainly the gut sense of 
the folks in finance that we have talked to at the bank so we 
think it is a terrifically important issue.
    Chairman Luetkemeyer. Anybody else want to comment on that? 
No, OK. Basically, we are finished here. Would anybody like to 
have a closing comment? I can go down the line here and I can 
give everybody about a minute, minute and a half to just make a 
couple closing comments on issues that came up that you would 
like to talk about that maybe weren't thoroughly discussed or 
reiterate one specific point. Mr. Fromer.
    Mr. Fromer. Thank you, Mr. Chairman. I think the point that 
I would make is that simply a reiteration of the view that 
there is an opportunity now and a lot of experience that, I 
think, regulators here and abroad can use now to do a complete 
review, specifically around these individual actions and the 
interaction among them because there is an interdependency. And 
in doing so, I would also add that we obviously went through a 
tumultuous time 10 years ago and we have done an enormous 
amount of work to address the results of the crisis.
    And these are extremely highly capitalized institutions, as 
we have talked about. I think no one really wants to go back 
and turn the clock on that. We are not looking at going back to 
the future, if you will. But we do think it is important to 
take stock of what we have done and make sure that we are doing 
it in the most cost-effective way possible.
    Chairman Luetkemeyer. Thank you. Mr. Baer.
    Mr. Baer. Just a couple thoughts. First, I do think it is 
important to acknowledge how tough capital regulation is. If 
the regulators come up with something very granular, we 
criticize them for credit allocation. If they give up and go to 
a leverage ratio and say every asset has the same risk, we 
criticize them for not thinking things through. So, it--I am 
sure there is some medium in there but it is not so easy and 
happy to find. And so, they deserve our empathy and they also 
deserve our notes and comment on that.
    I think we touched on it a little bit today but I do think 
the unseen world of bank examination is as important as the 
overt world of bank regulation. And that there are a lot of 
requirements going on out there that we don't even know about, 
and that it is very important for this committee and others to 
focus on.
    I would also just say, although I share the enthusiasm 
about equity, I did want to put in a word for debt, 
particularly for larger institutions that issue debt to the 
markets. That now, post-crisis, the way resolutions are 
conducted is actually quite loss absorbent and protects 
taxpayers.
    And there is about a trillion dollars of it out there, at 
least for our members. It also brings into play a group of 
investors and analysts who are quite worried about losing their 
money and also exert a significant amount of market discipline. 
So, I think that is a benefit.
    And I would also add that post-crisis, I think there have 
been--at least a GAO study and a couple of other academic 
papers looking at post-crisis debt pricing spreads. And there 
is no evidence that large banks are receiving a premium in the 
market or a discount, however you want to look at it. But they 
are being able to issue cheaper, as a result of some too-big-
to-fail premium.
    So, that is really market debt. Of course, the easiest way 
to figure out its market debt is to turn on a Bloomberg machine 
and see that it is priced the same way market debt is for other 
large institutions in other industries.
    Chairman Luetkemeyer. OK. All right, thank you. Dr. Holtz-
Eakin.
    Dr. Holtz-Eakin. Well, I applaud the committee for holding 
this hearing. And I think it is a good time to do a holistic 
review of the regulatory apparatus. And I would encourage the 
committee, the regulators, to look at these institutions 
holistically. I think the thing I find most troubling in many 
discussions is the notion that we can separate systemic risk 
over here and get a capital charge for that. Sort of a 
prudential regulation over here and an enhanced prudential 
regulation up here. Liquidity regulation over here. That is not 
the way the world works.
    And one of the reasons I think a more robust stress testing 
regime is desirable is it takes a holistic look at the 
performance of the institution through the stress. And I think 
that should be the focus.
    Chairman Luetkemeyer. Very good. Dr. Stanley.
    Dr. Stanley. Yes, a couple thoughts. One is I think there 
tends to be this trend or pattern that whenever we see a change 
in behavior, by banks in response to new capital requirements, 
that this is somehow a cost or a bad thing. And I don't think 
that is true.
    Mr. Noreika talked about how U.S. subsidiaries of foreign 
banks have decreased some of their capital markets' activities 
in the U.S. because of the intermediate holding company rule. 
Well, I don't think that Credit Suisse or Deutsche Bank, CBO 
desks activities before the crisis were doing any favors for 
the U.S. economy, nor were there enormous credit lines where 
they pulled all--borrowed all these dollars in the U.S. and 
then couldn't pay them back without Federal Reserve assistance. 
That--those capital markets' activities were not doing anybody 
any good. And the idea that they might have become more 
responsible about those activities I think might be a positive 
impact of the IHC rules.
    And also, just in terms of this competitiveness, the 
argument about competitiveness with Europe. And I think it is 
pretty clear that the U.S. banking sector is in a lot better 
shape than the European banking sector. There are still major 
concerns about the weakness of that sector. And, to some 
degree, I think the higher prudential requirements in the U.S. 
have been a competitive advantage of our banks because people 
know that our banks are safer and sounder and better to deal 
with.
    Chairman Luetkemeyer. Mr. Noreika.
    Mr. Noreika. Well, thank you, Mr. Chairman, and thank you 
for having me here today. I just want to conclude by saying, 
look, I am very optimistic about the banking sector, about the 
regulation of the banking sector.
    I think with the passage of the new law and the new 
regulated--regulatory heads finally in place, we have a real 
opportunity to take stock, to look at all the regulations that 
have been put in place and how they have been enforced over the 
past 10 years. I think when we talk and we hear the--
particularly the Vice Chairman for Supervision at the Fed, talk 
about tailoring and transparency. Those are welcome thoughts in 
the bank regulatory sphere.
    And I think now the devil is in the details. And, to me, 
the details are a soup-to-nuts review of how all of the 
cumulative effects of these regulations have impacted the 
various segments of the financial system. In particular, I 
think are the subsets that I talked about today. Those in the 
$100 to $250 billion range, which is going to merit a review by 
the Federal Reserve and those in the foreign banking realm.
    But, again, I think we have the approach here now to take a 
look and to tailor and to make more rational our regulation of 
these banks. And I think, hopefully in a few years, we will 
reap the results from that.
    Thank you.
    Chairman Luetkemeyer. Thank you. And thank all of the 
witnesses today for the testimonies. It has been great. You 
guys are fantastic.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    With that, this hearing adjourned.
    [Whereupon, at 3:50 p.m., the subcommittee was adjourned.]

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