Yellen takes questions on fed's balance sheet, CCAR process, role of new Vice Chair; says capital rules have not hindered banks' lending or their competitive position

The Senate Banking Committee on Tuesday, February 14, held a hearing to receive the semiannual monetary policy report from Federal Reserve Chairman Janet Yellen. While Yellen's remarks on economic factors, inflation, interest rates and other monetary issues were well covered in the media, she also touched upon a range of financial reform issues during the Q&A period. Testimony from the hearing is posted here.

Chairman Mike Crapo (R-IN) began his opening statement by highlighting the importance of regulatory reform. He said 2016 was "the eleventh consecutive year that the US economy failed to grow by more than 3%. One way to improve our economic growth is to study and address areas where regulations can be improved … We all need to better understand the combined impact of these rules on lending, liquidity, cost for small financial institutions and broader economic growth. It is time to reassess what is working and what is not." Crapo said he was encouraged by President Trump's recent executive order outlining "core principles" for regulating the financial system and directing the Treasury secretary to consult with regulators about "how well existing laws and regulations promote or inhibit economic growth." Crapo said he expects the Fed's new vice chair for supervision (once that person has been nominated and confirmed) to "play an important role in striking this balance" so that banks are not "drowned by unnecessary compliance costs."

Crapo said he was also encouraged by the Fed's recent steps to exempt certain banks from the qualitative portion of the Comprehensive Capital Analysis and Review (CCAR) process, which is associated with stress tests. The chairman added that he wants to address Dodd-Frank's $50 billion asset threshold for enhanced prudential regulation of larger banks under Dodd-Frank, saying he hopes to "craft a more appropriate standard" through a bipartisan approach. Crapo also noted that it had been nearly a decade since Fannie Mae and Freddie Mac were placed into conservatorship, and it was important to build bipartisan support for "a pathway forward" on housing finance reform. "My goal is to work with Ranking Member Brown and other members of the committee to identify bipartisan approaches that we can quickly get signed into law. At the same time, we plan to start working on housing finance reform, flood insurance sanctions, and legislation to boost economic growth in the country."

Ranking Member Sherrod Brown (D-OH) said that, while the economy was growing at a slow but steady pace, many parts of the nation still suffered from income disparities between white and black families, foreclosures and "underwater" mortgages. President Trump and the Republican majority have created uncertainty around health insurance, access to export markets, immigration and the prospect of a "20% sales tax" for importers, he said. Brown said many of the president's Cabinet nominees were "amazingly ethically challenged" and would have stepped aside in previous years.

Brown said the new administration is "furthering a billionaire special-interest agenda" that will "threaten Wall Street reform based on the false [premise] that banks are not lending." Brown expressed dismay that "many of my Republican colleagues are dead set on going beyond the reasonable, consensual, bipartisan adjustments and seeking to repeal reforms that are key to preventing the next devastating financial crisis," such as capital requirements and the designation of risky non-bank financial firms. "They are going after the rules that their former employers don't like, they're trying to take away the financial regulators' freedom to make difficult decisions that will keep our financial system stable. These priorities are wrong." Brown said a poll had shown that 80% of Americans "agree we need tough rules and stronger, not weaker, penalties for Wall Street." He acknowledged the contribution to financial reform made by Fed Governor Daniel Tarullo, who announced last week that he would step down in April.

Federal Reserve Chairman Janet Yellen's opening statement focused entirely on monetary policy and the various factors making up the US economic outlook.

Questions

New Vice Chair of Supervision. In his questions, Chairman Crapo asked Yellen what sort of role she envisioned for the new vice chair for supervision, noting that Tarullo had been filling that role, and whether the forthcoming appointee would have a portfolio similar to Tarullo's. Yellen said the vice chair would head up the Fed's Supervision and Regulation Committee and would "coordinate our efforts" in the area of new rulemaking. The person will also represent the Fed Board on international negotiations of financial regulatory standards, including Basel III, and would fulfill statutory obligations like testifying before Congress on bank supervision.

Executive order on financial regulations. Crapo asked if Yellen believes it's important to promote the "core principles" in President Trump's executive order, and if she plans to work with the Treasury secretary and other FSOC members "to ensure this review occurs." Yellen said she agreed with the order's list of principles, and she looked forward to working with the secretary and other FSOC members on the regulatory review required by the order.

Later on, Ranking Member Brown asked Yellen to provide the Banking Committee with whatever "information or conclusions" the Fed gives to Treasury or FSOC as part of the process of carrying out the president's executive order on regulations. Brown said he is concerned about another executive order requiring two rules to be withdrawn for every new rule that is promulgated by agencies. Yellen said she didn't believe independent agencies like the Fed are "explicitly covered" by the order, and added that it was important to look for ways to mitigate the burdens posed by regulations.

GSE reform. Chairman Crapo asked if Yellen believes that finding a "durable, comprehensive solution" to the housing finance market is "urgently needed." Yellen said that bringing private capital back into the mortgage market is "important, and I would hope that Congress would decide explicitly on what the government's role is, and if there are guarantees, that [such guarantees] would be recognized and priced appropriately."

Fed's Balance Sheet. Crapo then turned to the Fed's large holdings of mortgage securities and other assets, and asked what the benefits are of "starting to let the balance sheet run off rather than relying solely on short-term rate hikes to tighten policy." Yellen said the Fed only resorted to buying long-term assets after the financial crisis, when unemployment was high, inflation was low and "extraordinary support was needed." While she couldn't "put a number" on what size the Fed's holdings will ultimately be, "I would anticipate a balance sheet that's substantially smaller than at the current time," and she said the Fed would like the balance sheet to consist primarily of Treasuries.

Yellen said the Fed doesn't want to use "fluctuations in our balance sheet policy as an active tool of monetary policy management." So when the Fed judges that the economy is on a solid course and the federal funds rate is high enough that it could address weakness by cutting it, "we will stop reinvestments or diminish them and allow our balance sheet to shrink in an orderly and predictable way. The committee has decided that it will not sell mortgage-backed securities, but as principal matures, we will begin to allow those assets to run off our balance sheet." She said the Fed wants to wait to start this process "until the process of normalization is well underway."

Later on, when Bob Corker (R-TN) asked her why the Fed is still reinvesting in these securities, Yellen said the Fed recognizes that allowing these assets to run off "results in some tightening of financial conditions. And so, before we turn that process on … [we] want to make sure that we have adequate ability through our overnight interest rate moves to meet the needs of the economy, particularly if it were to weaken some … We want to make sure we have enough scope and the economy is strong enough that that run-off wouldn't create a problem for the economy."

Banks' ability to lend. In his questions, Ranking Member Brown began by noting that Yellen had previously testified that the banking system is much more safe and resilient than before the crisis. Referring indirectly to President Trump, Brown noted that some have contended that banks are not lending because of overregulation, and asked if she thought that was true. Yellen said a recent survey by the National Federation of Independent Business (NFIB) "indicated that only 4% of respondents were unable to get all of the loans that they needed, and the fraction of businesses ranking 'inadequate access to credit' as their main problem stood at 2%, which is an extremely low number."

Brown then noted that some people have argued that US banks cannot compete with their foreign counterparts because of regulations. Yellen told him that US banks "are generally considered quite strong relative to their counterparts" because of strong capital and price-to-book ratios that are higher than foreign banks'. "They're gaining market share, and they remain quite profitable," she said. Brown said that, if Dodd-Frank rules are repealed, "Wall Street will most assuredly be right back to the risky and reckless behavior we experienced before you took this job back before the crisis."

Later in the hearing, Elizabeth Warren (D-MA) took a similar tack with Yellen, asking her to examine Republicans' assertions that US banks are hoarding capital and cannot compete with foreign banks. Yellen told Warren that, over the last year, "C&I loans grew over 7% and small C&I loans … grew almost 4%. So we have seen healthy growth in actual lending in the economy." When Warren mentioned National Economic Council Director Gary Cohn's recent contention that banks "have been forced to literally build capital instead of lending capital to their clients," Yellen told her, "It's not a requirement that [banks] take money and stick it in a safe where it can't be used. It's a requirement that they finance the lending that they want to do with a certain amount of capital and not only with debt. So the capital is used to make loans." Yellen later told Warren that US banks were competitive: "They have higher market values relative to their book values and they are capturing market share from European banks."

CCAR relief for some banks. In his questions, Richard Shelby (R-AL) asked if Yellen intended to remain in office for the last year of her term; Yellen said she did. At Shelby's request, Yellen outlined the Fed's recent rule tailoring the CCAR process for banks with less than $250 billion in total consolidated assets. She said that, at the end of a five-year review process, the Fed decided that "the capital planning processes of those smaller institutions could be adequately reviewed and commented on through our normal supervisory processes and that it was appropriate to exempt them from the qualitative portion of that capital review. But we still are subjecting them to our stress tests and requiring that they conduct stress tests themselves."

Clearing platforms. In his questions, Jack Reed (D-RI) asked Yellen for an update on the Fed's efforts to ensure that the central clearing platforms mandated by Dodd-Frank are adequately protected from failure. Yellen said Dodd-Frank's Title VIII created a structure in which the Fed, CFTC and SEC are responsible for making sure that "the key infrastructures of our financial system are managing their own risks successfully. And we're cooperating with the other regulators in our examinations to make sure that appropriate risk management standards are in place."

Cybersecurity. Sen. Reed noted that the Fed has recently released a notice of a proposed rulemaking requiring board members to have adequate expertise in cybersecurity issues. Reed said he has been involved with drafting a bill that would apply "not just to financial institutions but publicly held companies, because the cyber threat is not limited, it is ubiquitous." Yellen told him cybersecurity is a "major, major risk that financial firms face," and that, while boards of directors generally appreciate the seriousness of cyber-threats, "my sense is … sometimes they don't have a comprehensive or enterprise-wide view of the institution's capabilities in this area."

Problems with CCAR process. In his questions, Pat Toomey (R-PA) described concerns he has with the Fed's CCAR process, which he called "enormously expensive" for banks, and noted a GAO report suggesting that the CCAR models and testing procedures used by the Fed are not transparent. Toomey said the GAO had also found that the Fed does not sufficiently manage risks associated with the models it uses; that it has not assessed whether CCAR is inadvertently procyclical, despite the intent that it be counter-cyclical; and that CCAR's implicit risk weights are "very different from those of the banks." Given those issues, Toomey asked Yellen if CCAR is "at least somewhat duplicative" and if she would consider "bringing it to an end at some point in the foreseeable future."

Yellen told him CCAR is a key part of the Fed's regulatory process and is "a very detailed, institution-specific, forward-looking assessment of the risks in the firm's balance sheet. And I think it's been a cornerstone of our efforts to improve supervision, especially of the largest banking institutions whose stability is really critical to overall US financial stability." She said the GAO had also concluded that the stress tests "have been useful and have played a useful role. They did not recommend that we end them." The report made specific recommendations with which the Fed agrees and is working on, and she noted the Fed's recent action to exempt most banks with less than $250 billion in assets from the qualitative regime of CCAR. Toomey told her that ending the CCAR process would not necessarily mean ending the stress tests. He said he hoped that the Fed would not issue any new regulations until the new vice chair and two other board members are confirmed.

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