Treasury releases report on financial regulations

Report required by executive order offers extensive recommendations for changes to bank capital rules, stress tests & living wills, Volcker Rule, community banks, CFPB, CRA, mortgage lending

Early this evening (Monday, June 12), the Treasury Department formally submitted a report to President Trump that comprehensively evaluates how the post-crisis financial regulatory framework aligns with seven "core principles" enunciated in an executive order issued by the President on Feb. 3. Those principles included guidelines such as empowering Americans to make independent financial decisions and informed choices in the marketplace; preventing taxpayer-funded bailouts; fostering economic growth through more rigorous analysis of the impact of rules; and enabling American companies to be competitive with foreign firms. Attached with this alert please find a PDF of Treasury's report (149 pages) and a press release on the report issued by Treasury.

In the course of assembling the report, Treasury consulted with member agencies of the Financial Stability Oversight Council (FSOC), including the Federal Reserve Board of Governors, the Office of the Comptroller of the Currency (OCC), the Consumer Financial Protection Bureau (CFPB), the Securities and Exchange Commission (SEC), the FDIC, the CFTC, the Federal Housing Finance Agency (FHFA) and the National Credit Union Administration (NCUA). Treasury also "consulted extensively with a wide range of stakeholders." Treasury is preparing two other reports required by executive orders issued on April 21: one to review the "orderly liquidation authority" established by Dodd-Frank to safely wind down large, failing financial institutions, and another to review the process by which the FSOC designates non-bank financial firms and financial market utilities as systemically important (SIFIs).

This report focuses on the depository system, and as such does not cover other areas that Treasury says will be the subject of future reports, such as: housing finance reform; capital markets; the asset management and insurance industries; and non-bank financial institutions, financial technology and financial innovation. The report's recommendations for potential changes to various Dodd-Frank rules and other regulations could be achieved through legislation or actions initiated by the regulatory agencies or the executive branch. While the report offers dozens of specific recommendations, some of the broader proposals are outlined below.

Regulatory structure. The report says Congress should take action to reduce fragmentation, overlap and duplication in the financial regulatory structure. "This could include consolidating regulators with similar missions and more clearly defining regulatory mandates. Increased accountability for all regulators can be achieved through oversight by an appointed board or commission," or in the case of director-led agencies, allowing the president to remove the director for any reason. Congress should also expand the FSOC's authority to play a larger role in coordinating and directing regulatory and supervisory policies. "This can include giving it the authority to appoint a lead regulator on any issue on which multiple agencies may have conflicting and overlapping regulatory jurisdiction."

Congress should also reform the structure and mission of the Office of Financial Research, such that OFR becomes "a functional part of Treasury, with its Director appointed by the Secretary, without a fixed term and subject to removal at will," with its budget under the control of the appropriations process, the report states.

Capital and liquidity rules. The report recommends "appropriate tailoring" of Dodd-Frank's DFAST (stress test), Comprehensive Analysis and Review (CCAR), Liquidity Coverage Ratio (LCR) and single-counterparty credit limit (SCCL) regimes. The DFAST participation threshold should be raised to $50 billion in total assets (from the current threshold of more than $10 billion), and banking regulators should have authority to further calibrate this threshold on an upward basis. The mid-year DFAST cycle should be eliminated, and the number of supervisory scenarios should be reduced from three to two. Dodd-Frank section 165's threshold for enhanced prudential standards "should be raised to be better tailored to the complexity of bank holding companies," and the Fed "should also revise the threshold for the application of CCAR to match the revised threshold."

The report says the scope of application of the LCR should be narrowed to apply only to internationally active banks, and regulators should consider establishing a "regulatory off-ramp" from all capital and liquidity requirements, nearly all aspects of Dodd-Frank's enhanced prudential standards, and the Volcker Rule. Such an "off-ramp" was a feature of the CHOICE Act (HR 10), a Dodd-Frank repeal bill passed by the House on June 8, 2017. Among other changes, the report also says the Federal Reserve should "reassess assumptions in the CCAR process that create unrealistically conservative results," improve its modeling practices by better recognizing firms' unique risk profiles; and consider changing the CCAR process to a two-year cycle. The Fed also should subject CCAR's stress-testing and capital planning review frameworks to public notice and comment. The report proposes that banking regulators should delay adopting the Net Stable Funding Ratio and Fundamental Review of the Trading Book standards until the US can appropriately assess and calibrate them.

Community banks. Among many other proposals, the report says bank regulators should explore exempting community banks from the risk-based capital regime implementing Basel III standards. "In addition, if required, Dodd-Frank's Collins Amendment should be amended." Treasury recommends raising the asset threshold of the Federal Reserve's Small Bank Holding Company and Savings and Loan Holding Company Policy Statement to $2 billion (from the current $1 billion); changing the existing regulatory capital requirements and other burdensome rules for community banks; and critically reviewing capital requirements applicable to de novo banks. The application process of obtaining deposit insurance should also be significantly streamlined.

CRA (Community Reinvestment Act). The report says the CRA statute "is in need of modernization … It is very important to better align the benefits arising from banks' CRA investments with the interest and needs of the communities that they serve and to improve the current supervisory and regulatory framework for CRA. Treasury expects to comprehensively assess how the CRA could be improved to achieve these goal."

'Living wills.' The report recommends changing the threshold for compliance with living will requirements from the current level of $50 billion to match the revised threshold for application of enhanced prudential standards. Agencies should formalize a change of the living will process to a two-year cycle. The agencies could require firms to provide notice of material events that occur between living will submissions. The FDIC should be removed from the living wills process.

Foreign banking organizations (FBOs). Among other proposals, the report says the application of enhanced prudential standards and living will requirements to FBOs should be based on their US risk profile, and not on global consolidated assets. The threshold for intermediate holding companies (IHCs) to comply with US CCAR should be raised from the current $50 billion level to match the revised threshold for enhanced prudential standards. The Fed should also recalibrate its long-term debt and TLAC rule by considering the foreign parent's ability to provide capital and liquidity resources to the US IHC.

Volcker Rule. The report contains a large number of recommendations for changes to the Volcker Rule, which bans banks from engaging in proprietary trading or having relationships with certain private funds. Treasury says banking entities with $10 billion or less in assets should be exempt from the Volcker Rule. Banking entities with over $10 billion in assets that are not subject to the market risk capital rules should also be exempted from the Volcker Rule's proprietary trading prohibitions. Treasury proposes simplifying the definition of proprietary trading by eliminating the "60-day rebuttable presumption." Regulators should give banks additional flexibility to adjust their determinations of the reasonable amount of market-making inventory. Consideration should be given to permitting a banking entity that is sufficiently well-capitalized, such that the risks posed by its proprietary trading are adequately mitigated by its capital, to opt out of the Volcker Rule altogether, if the institution remains subject to trader mandates and ongoing supervision and examination.

CFPB. The report asserts the CFPB is not sufficiently accountable to the president or Congress. Among other proposals, "the most straightforward remedy is to make the Director removable at-will by the President. As an alternative, the CFPB could be restructured as an independent multi-member commission or board, which would create an internal check on the exercise of agency power … . The CFPB should be funded through the annual congressional appropriations process to enable Congress to exercise greater oversight and control over how taxpayer dollars are spent."

Mortgage lending. Among many other recommendations, the report says the CFPB should engage in a review of the Qualified Mortgage (QM) rule "and work to align QM requirements with GSE eligibility requirements, ultimately phasing out the QM Patch and subjecting all market participants to the same transparent set of requirements." Treasury also proposes revising the Points and Fees Cap for QM Loans and increasing the threshold for making small-creditor QM loans.

Secondary mortgage market. The report recommends repealing or substantially revising Dodd-Frank's residential mortgage risk retention requirement, among other proposals. "If the requirement is revised rather than repealed, the legislation should designate one agency from among the six rule-writing agencies to be responsible for the interpretation of the risk retention rule." Regulators should also clarify limited assignee liability for secondary market investors. Many of these issues are likely to be addressed in a subsequent report on housing finance reform.

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ATTACHMENTS

Financial system

Treasury release