U.S. GOVERNMENT PUBLISHING OFFICE

33–484 PDF WASHINGTON : 2019

S. HRG. 115–408 

THE SEMIANNUAL TESTIMONY ON THE FEDERAL 

RESERVE’S SUPERVISION AND REGULATION OF 

THE FINANCIAL SYSTEM 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED FIFTEENTH CONGRESS 

SECOND SESSION 

ON 

EXAMINING THE EFFORTS, ACTIVITIES, OBJECTIVES, AND PLANS OF 

THE FEDERAL RESERVE BOARD WITH RESPECT TO THE CONDUCT, 

SUPERVISION, AND REGULATION OF FINANCIAL FIRMS SUPERVISED 

BY THE FEDERAL RESERVE BOARD 

NOVEMBER 15, 2018 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: https://www.govinfo.gov/ 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

MIKE CRAPO, Idaho, Chairman 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

PATRICK J. TOOMEY, Pennsylvania 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

DAVID PERDUE, Georgia 

THOM TILLIS, North Carolina 

JOHN KENNEDY, Louisiana 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana 

BRIAN SCHATZ, Hawaii 

CHRIS VAN HOLLEN, Maryland 

CATHERINE CORTEZ MASTO, Nevada 

DOUG JONES, Alabama 

GREGG RICHARD, Staff Director 

MARK POWDEN, Democratic Staff Director 

JOE CARAPIET, Chief Counsel 

BRANDON BEALL, Professional Staff Member 

LAURA SWANSON, Democratic Deputy Staff Director 

ELISHA TUKU, Democratic Chief Counsel 

AMANDA FISCHER, Democratic Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

CAMERON RICKER, Deputy Clerk 

JAMES GUILIANO, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

THURSDAY, NOVEMBER 15, 2018 

Page 

Opening statement of Chairman Crapo ................................................................. 1 

Prepared statement .......................................................................................... 21 

Opening statements, comments, or prepared statements of: 

Senator Brown .................................................................................................. 2 

Prepared statement ................................................................................... 22 

WITNESS 

Randal K. Quarles, Vice Chairman for Supervision, Board of Governors of 

the Federal Reserve System ................................................................................ 4 

Prepared statement .......................................................................................... 23 

Responses to written questions of: 

Senator Brown ........................................................................................... 70 

Senator Toomey ......................................................................................... 74 

Senator Cotton ........................................................................................... 76 

Senator Rounds ......................................................................................... 77 

Senator Tillis ............................................................................................. 82 

Senator Warren ......................................................................................... 84 

Senator Cortez Masto ................................................................................ 89 

(III)

(1) 

THE SEMIANNUAL TESTIMONY ON THE FEDERAL RESERVE’S SUPERVISION AND REGULATION OF THE FINANCIAL SYSTEM 

THURSDAY, NOVEMBER 15, 2018 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:01 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Mike Crapo, Chairman of the Committee, 

presiding. 

OPENING STATEMENT OF CHAIRMAN MIKE CRAPO 

Chairman CRAPO. The Committee will come to order. 

Today we will receive testimony from Federal Reserve Vice 

Chairman for Supervision Randy Quarles regarding the efforts, activities, objectives, and plans of the Federal Reserve Board with respect to the conduct, supervision, and regulation of financial firms 

supervised by the Federal Reserve Board. 

We last heard from Vice Chairman Quarles in October on the 

Fed’s progress implementing S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. 

At that time the Fed had taken actions to implement some provisions of S. 2155, including those related to the 18-month exam 

cycle, high-volatility commercial real estate, and the Small Bank 

Holding Company Policy Statement. 

Since then, the Fed has taken new steps to implement key provisions of the bill. 

Recently, the Fed issued proposals revising the application of enhanced prudential standards across four categories of firms to reflect each category’s varying risks. These proposals are a step in 

the right direction, and I appreciate the Fed’s work to issue them 

quickly. 

I understand the amount of staff work that went into getting the 

proposals out, and thank you and your staff for your work on these 

proposals. 

The proposals would assign banking organizations to one of four 

categories based on their size and other risk-based indicators, including cross-jurisdictional activity; nonbank assets; short-term 

wholesale funding; off-balance-sheet exposures; and status as a 

U.S. global systemically important bank, or a U.S. G–SIB. 

The category to which an institution is assigned would determine 

the enhanced prudential standards and capital and liquidity requirements to which it would be subject. 
2 

I look forward to hearing how the application of certain enhanced 

prudential standards would address the risks associated with crossjurisdictional activity, nonbank assets, short-term wholesale funding, and off-balance-sheet exposures. 

The proposal incorporates a number of very positive changes to 

the current framework for regional banks, including relief from advanced approaches capital requirements; a reduced liquidity coverage ratio; changes to the frequency of supervisory and companyrun stress testing, and, in some cases, the disclosure of the results. 

Despite this positive step, the agencies have left a number of 

items unaddressed, including the treatment of foreign banking organizations; additional details on stress testing, including the Fed’s 

Comprehensive Capital Analysis and Review, or CCAR; and resolution planning. 

I encourage the regulators to revisit all regulation and guidance 

thresholds that were consistent with the outdated Section 165 

threshold to an amount that reflects actual systemic risk. 

Regulators have two options: use a systemic risk factors-based approach, or raise all thresholds to at least $250 billion in total assets to be consistent with S. 2155. 

There are also other noteworthy provisions of the bill on which 

the Fed, working with other regulators, has yet to act, including 

implementation of the Community Bank Leverage Ratio and the 

provision that exempted cash deposits placed at central banks by 

custody banks from the supplemental leverage ratio. The Fed 

should work promptly to issue proposals to address these critical 

outstanding issues. 

I was encouraged by Vice Chairman Quarles’ speech last week, 

particularly the emphasis on providing more transparency around 

stress testing and capital planning processes. 

Finally, last week all Republican Members of the Banking Committee sent a letter to the FDIC on Operation Choke Point. 

Operation Choke Point is an initiative in which Federal agencies 

devised and relied upon a list of politically disfavored merchant 

categories with the intent of ‘‘choking off’’ these merchants’ access 

to payment systems and banking services. 

Staff at the banking agencies use verbal recommendations to encourage banks to stop doing business with disfavored but legal 

businesses. 

I plan to look into how policy is communicated from the banking 

agencies to the regulated institutions more broadly. 

I appreciate Vice Chairman Quarles joining us today to discuss 

developments in the Fed’s supervision and regulation and look forward to hearing more about the Fed’s pending work to implement 

Senate bill 2155. 

Senator Brown. 

OPENING STATEMENT OF SENATOR SHERROD BROWN 

Senator BROWN. Thank you, Mr. Chairman, and thanks to Vice 

Quarles for joining us. Good to see you again. 

The Fed’s responsibility and Vice Chairman Quarles’ job is, as we 

know, to ensure that the economy works for average Americans— 

that if you work hard, you can get ahead; that Wall Street does not 

again crash the financial system and squander the pensions that 
3 

families worked their whole lives to earn; and that banks cannot 

cheat workers out of their hard-earned savings; and that executives 

are held accountable when they break the law. 

We know the Fed failed in its mission 10 years ago. The Fed had 

all the power it needed to prevent the crash. Its leaders in Washington were too complacent and too cozy with Wall Street to use 

their authority to rein in the largest banks and to protect American 

taxpayers. 

That is why immediately after the crash, we put in place rules 

to strengthen taxpayer protections from big bank risk and to protect consumers from predatory practices. 

The rules worked. Our system got safer, and the rules have not 

stopped banks from becoming more profitable than ever, as we see. 

The Fed released a report on Friday showing that two important 

measures of banks’ profitability—return on equity and average return on assets—hit a 10-year high in the second quarter of 2018. 

They have reported a 30-percent growth in loan volume since 2013, 

while experiencing a 10-year low in the share of loans that are not 

performing. 

But now, with legislation enacted earlier this year and the actions of this Administration, we are witnessing—piece by piece by 

piece—the dismantling of these protections for American workers 

and an undermining of the dignity of work. 

Since the last time Mr. Quarles testified before this Committee, 

we have two new developments that underscore this point. 

First, the Fed’s proposal to implement the bank giveaway bill, S. 

2155, goes far beyond what the authors of that legislation claimed 

the bill would do. The Fed’s proposed rule loosens protections for 

banks with more than $250 billion in assets—not small community 

banks, the way the bill was sold. We are talking about the Nation’s 

biggest financial institutions. Combined, these firms hold $1.5 trillion in assets. 

The Fed’s proposal also promises more goodies for the big banks, 

with rollbacks for large foreign banks expected in the next few 

months. This is despite the fact that the Fed’s own progress report 

said that foreign banks continue to violate anti– money-laundering 

laws and skirt Dodd–Frank requirements. No need today to go 

down that list of foreign banks. We all know who they are. We 

have talked about them in this Committee. Senator Cortez Masto 

has brought it up. I have brought it up. A number have brought 

it up. Yet we are saying to these foreign banks we sort of ignore 

the illegal things they do and continue to deregulate them. 

Vice Chair Quarles gave a speech last week announcing the Fed’s 

plans for the very largest domestic banks—a speech, frankly, that 

could have easily been written by one of those banks’ lobbyists. 

Mr. Quarles wants to weaken capital requirements for the 

megabanks, eliminating any leverage capital standards in stress 

tests. We got a preview of what this would look like in June when 

the Fed gave passing grades to three banks that had clearly failed 

their stress tests. Now Mr. Quarles wants to make this year’s giveaway permanent. 

The speech outlined a series of other changes to the Fed’s stress 

tests that would render them essentially meaningless. Mr. Quarles 

makes no secret of the fact he wants to ease up on the assumptions 
4 

that guide the tests, wants to eliminate portions of the tests, and 

wants to share with the banks the Fed’s internal models against 

which they are graded—you know, giving students the answers 

ahead of time. 

These changes, taken alongside the weakening of the Volcker 

Rule, other big bank leverage standards, and an abandonment of 

nonbank financial oversight, these changes amount to gutting the 

postcrisis protections we put in place that have worked marvelously for about a decade to protect American taxpayers future 

bailouts. Again, repeat, the banks are doing very, very, very well 

with these rules and regulations in terms of profitability and return, all of those things. So why do we think weakening those rules 

makes sense? 

It is not just I who says this. Stanley Fischer, the former Vice 

Chair of the Fed, called these combined rollbacks ‘‘mind boggling’’ 

and ‘‘very dangerous.’’ 

When regulators have not finished implementing Dodd–Frank, 

when the economy has not even gone through a full economic cycle, 

now is not the time to begin dismantling our postcrisis protections. 

It is the same story: Wall Street recovers, working families in 

Cleveland and Baltimore and Birmingham and Las Vegas do not. 

When Washington policymakers suffer from collective amnesia, as 

this Committee does, working families and savers and taxpayers 

too often end up paying the price. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Brown. 

Again, Vice Chairman Quarles, we appreciate you being with us. 

You may now make your statement. 

STATEMENT OF RANDAL K. QUARLES, VICE CHAIRMAN FOR 

SUPERVISION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. QUARLES. Thank you. Thank you, Chairman Crapo, Ranking 

Member Brown, Members of the Committee. I am grateful for the 

opportunity to testify on the Federal Reserve’s regulation and supervision of the financial system. 

My prepared remarks address two main topics: our efforts to improve regulatory transparency and our progress in making the 

postcrisis regulatory framework simpler and more efficient. I am 

mindful that this semiannual testimony, like my position as Vice 

Chairman for Supervision, is grounded in Congress’ efforts to 

strengthen and improve the Nation’s regulatory framework following the financial crisis, and this testimony reflects a critical element of those efforts: the desire and the need for greater transparency. 

Transparency is part of the foundation of public accountability, 

and it is a cornerstone of due process. It is also key to a well-functioning regulatory system and an essential aspect of safety and 

soundness as well as financial stability. Transparency provides 

firms clarity on the letter and spirit of their obligations. It provides 

supervisors with exposure to a diversity of perspectives. And it provides markets with insight into the condition of regulated firms, 

which fosters market discipline. Transparency increases public con-
5 

fidence in the role of the financial system to support credit, investment, and economic growth. 

The Federal Reserve has taken a number of steps since my last 

testimony to further increase transparency and to provide more information about our supervisory activities to both regulated institutions and the public. We recently improved our supervisory ratings 

system for the large financial institutions, better aligning ratings 

with the supervisory feedback that those firms receive. With our 

fellow banking agencies, we clarified that supervisory guidance is 

a tool to enhance the transparency of supervisory expectations and 

should never be the basis of an enforcement action. And we expect 

shortly to make final a set of measures to increase visibility into 

the Board’s supervisory stress testing program, including more 

granular descriptions of our models, more information about the 

design of our scenarios, and more detail about the outcomes we 

project. 

The report that accompanies my testimony today and that Ranking Member Brown referred to is another tool to keep Congress and 

the public informed about our work, the banking system, and the 

role of both in supporting the broader economy. As the report 

shows and as my written testimony discusses, the banking sector 

remains in strong condition, in line with strong U.S. economic performance, with lending growth, fewer nonperforming loans, and 

strong overall profitability. 

We are, however, very much aware of the dangers of complacency, and our report lists several priority areas of risk we will continue to monitor closely, including cyber and IT risks at supervised 

firms of all sizes. 

Improving regulatory efficiency is another core element of our 

current efforts. Tailoring regulation and supervision to risk has 

been a programmatic goal of the Federal Reserve for more than two 

decades. The motivations are clear: supervisory resources are not 

limitless; supervision is not costless, either to the public or to supervised institutions. Activities and firms that pose the greatest 

risk should receive the most scrutiny, and where the risk is lower, 

the regulatory burden should be lower as well. 

This principle guided Congress and the agencies in designing the 

postcrisis regulatory framework, and it has guided our implementation of the Economic Growth, Regulatory Relief, and Consumer 

Protection Act. On this front, as my written testimony details, we 

have made substantial progress. 

Our most significant step came 2 weeks ago when the Board 

issued two proposals to better align prudential standards with the 

risk profile of regulated institutions. These proposals would significantly reduce regulatory compliance requirements for firms in the 

lowest risk category, including most institutions with between $100 

billion and $250 billion in assets. Firms with $250 billion or more 

in assets or firms between $100 billion and $250 billion that meet 

a risk threshold will face reduced liquidity requirements. The proposals would largely maintain existing requirements for the largest 

and most complex firms. 

These new categories draw on our experience administering enhanced prudential requirements and other postcrisis measures, and 

they move toward a more risk-sensitive, nuanced framework, where 
6 

riskier activities and a larger systemic footprint correspond to higher supervisory and regulatory requirements. 

I have detailed several other efforts to improve regulatory efficiency in my written testimony, including simplifying and tailoring 

requirements under the Volcker Rule. 

Our work to improve regulatory efficiency is not done, and we expect to make additional progress in the months ahead on a number 

of issues. In particular, we are working with our counterparts at 

the OCC and FDIC on a community bank leverage ratio proposal. 

I look forward to making progress on that and other efforts and to 

participating in the Committee’s oversight of our work. 

Thank you, and I look forward to answering your questions. 

Chairman CRAPO. Again, thank you, Mr. Quarles. 

My first question is really just one on timing for what is coming 

next. I do appreciate the work the staff has gone through, truly. 

I know the amount of work it has taken for you to move as expeditiously as you have. I am concerned, however, that it is difficult to 

get a full picture of what the supervisory and regulatory landscape 

will look like until other proposals on foreign banks, resolution 

planning and capital planning, and stress testing are out. And I encourage you to keep the heat on to move quickly and would appreciate any updates you might have on timing. 

Mr. QUARLES. Certainly, Mr. Chairman. So as I indicated, our 

implementing proposal which we are working on jointly with the 

OCC and the FDIC on the community bank leverage ratio proposal 

we expect very soon. And, again, I hope that the speed with which 

we put forward the main implementing proposal indicates that 

very soon really will be very soon. 

Shortly following after that, I think we will have proposals for 

modernizing or bringing up to date the resolution framework and 

foreign banking organizations, tailoring for foreign banking organizations. I view the tailoring for foreign banking organizations as a 

somewhat separate question from implementation of S. 2155. We 

have been considering, and obviously we need to consider, and will 

come up with a proposal for that. But the domestic operations of 

foreign banking organizations I do not think are one-for-one correspondent with domestic firms of the same size because those intermediate holding companies, they interact with branches that are 

subject to a different regulatory regime here. They are parts of 

larger organizations. 

So I think there is tailoring that can be done. We need to ensure 

that we have a level playing field, that firms that are alike are 

treated alike. That is very important. But I do think it is a separate implementation question than 2155 implementation. 

Chairman CRAPO. All right. Thank you very much. 

Are you familiar with the letter or have you seen the letter that 

the Republican Members of this Committee recently sent to the 

FDIC on Operation Choke Point? 

Mr. QUARLES. I have seen that letter, yes. 

Chairman CRAPO. And are you familiar with Operation Choke 

Point, what it is? 

Mr. QUARLES. I am familiar with what I have read about it, yes. 

Chairman CRAPO. OK. As I indicated in my opening statement, 

I am very concerned with the lack of accountability in the super-
7 

visory process. What we are finding is that many of the regulators 

who are verbally giving instructions to those regulated that are not 

actually contained in their authority or the law, and that, frankly, 

financial institutions, particularly a lot of our smaller financial institutions, feel an incredible pressure from things that are not coming even from regulations or guidances, but just from verbal communications. 

This raises the question to me of whether those who are conducting the supervision throughout our agencies, our financial regulatory agencies, are engaging in regulatory direction and activity 

that is not authorized by law or regulation. 

My question to you is: What are you doing to make sure that 

staff at the Federal Reserve is accountable to you? And is there 

anything Congress can do to make sure that you have the tools 

necessary to make staff at the agency accountable to you? 

Mr. QUARLES. So I appreciate that concern, and I would share 

that concern. Obviously, if there were instances where examiners 

were communicating and requiring banks to take action that was 

not required by regulation and that was not transparent to those 

above them in the hierarchy, you know, obviously that would be extremely concerning. 

We have a pretty vigorous training program at the Fed. I personally have undertaken as well to spend time in the various reserve 

banks in dealing with the supervisors on the ground, conferences 

of all the supervisory personnel, leadership conferences. We are 

working hard—none of that is terribly visible. All that is within the 

system. But we are working hard to ensure that our expectations 

for supervisory practice as well as our regulatory process is very 

clear to those who are on the ground. 

Chairman CRAPO. Well, thank you. I appreciate that and I—well, 

I appreciate your attention to that. As the letter that some of the 

Members of this Committee recently sent to the FDIC, we want to 

assure that all of our regulatory agencies in the financial system 

follow their own regulations and the law of the United States rather than, frankly, social managing ideas that they have with regard 

to which businesses in America should be allowed to do business. 

It is an extremely serious concern, and I appreciate your attention 

to this. 

Senator Brown. 

Senator BROWN. Thank you, Mr. Chairman. 

Following your speech, one bank analyst told clients that your 

proposed changes are ‘‘a positive for the biggest banks by providing 

capital and compliance relief. It reinforces our deregulatory theme 

for the banking sector. It shows how deregulation can proceed, even 

with Democrats retaking the House of Representatives.’’ 

Two questions. Do you think this analysis of the Fed’s actions is 

accurate? And, second, can you guarantee this Committee that 

when the Fed is done, megabank capital standards will not decrease relative to where they are today? 

Mr. QUARLES. As I have indicated each time I talk about increasing transparency and improving the efficiency of that system, including our stress testing proposals, our objective is not to have 

any—certainly no material effect on the resiliency of the system 

and not to have any material effect on the loss-absorbing capacity 
8 

of these largest firms. I think that there are things that we can do 

that improve the incentives, that reduce burden, that are more appropriate in a democracy about the transparency that is required 

about regulatory expectations without undermining the safety and 

soundness of the system and without, again, in any way reducing 

the loss-absorbing capacity of the system. 

Senator BROWN. But does that mean no diminishing of the capital standards? 

Mr. QUARLES. Capital standards are a very important element of 

that, but I think we also look broadly. So it is not just capital 

standards. It is all the cushions that are built into the capital 

structure. 

Senator BROWN. It includes capital standards? 

Mr. QUARLES. Capital standards are included in my understanding of loss absorbency that we do not intend to reduce. 

Senator BROWN. So was that analysis of your speech fair and accurate? 

Mr. QUARLES. I think it did not—I mean, to the extent that they 

believe that there would be material capital reductions for the largest firms, I do not think they were—I think they ignored the clear 

statement that I made, that our intention is not to—— 

Senator BROWN. This is a group of people that want those standards diminished, and there is, I mean, almost an arrogance to it: 

‘‘Well, we know the regulators will help us do that even though 

those people in the House of Representatives will not.’’ 

Mr. QUARLES. So I believe that it is—I know from what it is that 

we are proposing that it is possible to have, again, a material improvement in the efficiency and reduction in the cost of our regulatory system without undermining what is at the core of it, which 

is improved resiliency and strong loss absorbency for these firms. 

Senator BROWN. You outlined a lot of bold changes in your 

speech. Are you speaking for the whole Fed Board in speeches like 

that? 

Mr. QUARLES. In some cases the Fed Board has made decisions 

resolving this. We have come out with proposals. In other cases— 

and I have tried to be clear about this when that was the case— 

I have said what it is that I would place before the Board in short 

order. 

Senator BROWN. Thank you. Thanks for your honesty. This is 

short of an admonition, but we have noticed already, even though 

Chair Yellen—and every Chair is different. I get that. Chair Yellen 

wanted unanimity when the Board made decisions, and when one 

of the Board members, the only non– Trump Board member, voted 

the other way, they went ahead. I hope that—I said this is short 

of an admonition, but I hope that you keep that in mind, that the 

best way to do this is consensus. And if it means convincing a wayward or two Board member, one or two Board members to come 

around, be patient and try to do that, or look elsewhere. 

Mr. QUARLES. So we do look for consensus, and certainly there 

is a process on the Board that I think each Board member would 

say has taken every Board member’s thoughts into account and is 

open, and adjustments have been made even where at the end of 

the day the Board cannot be unanimous. I do not think that unanimity can be the sole measure of legitimacy or the whole Dodd– 
9 

Frank Act would be illegitimate. It was not passed unanimously. 

But we do at the Board have a very robust process to ensure that 

every Board member’s voice is heard. 

Senator BROWN. I appreciate that, but a regulatory body is very 

different from a politically elected—I mean, you, I assume—I think 

I can assume your political party, but it does not matter. You are 

on the Fed, and regardless of Ms. Brainard or Mr. Quarles or anybody else on that Board, political party should not really matter. 

One more question. You said the Fed intended to give 

megabanks a cheat sheet for the stress test in the coming years, 

handing over details about the Fed’s models, how the Fed predicts 

hypothetical loan performance, even letting banks comment on the 

Fed’s scenarios that predict what economic shocks may occur over 

the next year. 

Given the lead-up to the 2008 crisis, why are you so confident 

that banks will not optimize their assets to gain the models? Isn’t 

that exactly what banks did to game credit rating agency models 

for mortgage-backed securities? 

Mr. QUARLES. So in our transparency proposal, we have tried to 

strike a balance between more transparency, again, which I think 

is appropriate for a number of reasons—again, not just due process, 

but also to improve the quality of our models. The more that people 

understand them, not just the industry but academics, Congress, 

the public, the more input that we can receive on how to improve 

them. 

But as I have said a number of times, I do think that there is 

a concern about the so-called mono model problem, and that if we 

were completely transparent, that whatever idiosyncracies there 

are in our model would become the locuses of risk throughout the 

entire system, and we could end up making the system more fragile rather than less. And so we are not being completely transparent about our models even in these increased transparency proposals that we have made for that reason. 

Senator BROWN. Well, and I will close, Mr. Chairman. I appreciate the word ‘‘transparency’’ used at least six times in that answer, and you and I when we had breakfast talked about that, and 

I appreciate that view. But this is more like in some ways giving 

banks the teacher’s edition of the textbook with the answers listed 

out in the back when you call giving them that transparency. We 

all want transparency in your deliberations, and I think the Fed 

has made progress under—really under Bernanke and Yellen and 

now. But I just caution you with the word ‘‘transparency’’ when it 

is giving information to the people that you are stress testing. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Corker. 

Senator CORKER. Thank you. We welcome you here, and while I 

have enjoyed working with all of those who have held your position, it is good to have someone who is actually confirmed and in 

this role in the appropriate manner. 

I know there are going to be comments based on my staff input 

earlier today relative to some of the tailoring issues and some concerns and people alluding to bank profits. But when we have tried 

to do safety and soundness, put in place safety and soundness regulations for institutions—and I think many of us here strongly sup-
10 

port higher capital levels to make sure that they are safe and 

sound. But we really do not look at trying to manage bank profits 

when we do that, do we? 

Mr. QUARLES. No. 

Senator CORKER. Talk to us a little bit about what you think 

about when you go through those processes. 

Mr. QUARLES. So I think that we have two principal concerns as 

regulators. We have a concern for the safety and soundness of individual institutions, and we have a concern for the safety and 

soundness of the system as a whole and for the efficiency of the 

system as a whole because all of us as citizens benefit from the efficiency of the financial sector. That is what provides the support for 

economic growth, provides credit for small businesses and businesses generally. 

So really irrespective of bank profitability, our concern is that 

that system should be operating as efficiently as possible and that 

our regulation of that system, while achieving the objective of safety and soundness, is doing so in the most efficient way practicable, 

because when we do that, we support economic growth that benefits us all. 

Senator CORKER. I notice the FDIC appropriately is moving down 

the path of making sure they have a rulemaking in place relative 

to private flood insurance, and I think many of us here would like 

to see steps taken to ensure that institutions are accepting private 

flood insurance. What is the status of that right now at the Fed? 

Mr. QUARLES. So we share the view that private flood insurance 

should be acceptable, and we are working to ensure that that is understood throughout our supervisory system, so as a supervisory 

matter that private flood insurance will be acceptable. 

Senator CORKER. So we look forward to you moving ahead with 

that, and hopefully that will happen very soon. 

The GSEs have been something of debate here since 2008, unsuccessfully. I know that the new Congress likely will take up legislation. My sense is the Administration potentially will try to lead on 

that issue by putting in place some things they can do on their own 

accord and then coming back and talking with Congress about 

things that are necessary to fully implement reforms as it relates 

to Fannie and Freddie. Currently they are in conservatorship, as 

you know. 

I am just curious. Some people on this Committee may disagree 

with the whole creation of FSOC. Some people I think would have 

thought maybe the Fed’s responsibility was that. But we do have 

FSOC, and we do have some firms that are designated as systemically important. 

I am just interested in why the Fed and why FSOC has not chosen to say that Fannie and Freddie themselves, with such a huge 

concentration and such importance systemically to the banking system itself, have not even during conservatorship chosen to designate them as systemically important. 

Mr. QUARLES. Well, ultimately that is a question for the FSOC 

as a whole as opposed to just the Federal Reserve. 

Senator CORKER. Would you all push for that, though? You have 

a very strong voice in that. 
11 

Mr. QUARLES. I think that the right—myself, I think that the 

right answer for the GSEs is to have a comprehensive solution, and 

FSOC designation in the context of that, I think it needs to be 

thought of as what is a comprehensive solution for these institutions. And so I would not want to do anything piecemeal until it 

was clearer what the whole solution is going to be. I know that the 

Treasury and the FHFA are both working hard on that, and I 

think as we see how that evolves—— 

Senator CORKER. So you look at designating someone with $3 

trillion in assets as part of a reform solution, not something that 

you deem to be important as it relates to systemic risk? That is an 

odd response, just for what it is worth. 

Mr. QUARLES. Well, again, I think that everything that involves—— 

Senator CORKER. Just for what it is worth, you know, I support 

you and I appreciate your being here. It feels like the Fed is taking 

a political look at this and not wanting themselves to be entangled 

in versus pushing for the fact that these institutions, if they ever 

survive conservatorship, certainly would need to have capital and 

all of those kinds of things. And it feels like you all are kind of 

dodging a political issue to keep yourselves from being maybe 

wounded by taking a step that is appropriate. Is that kind of where 

the Fed is today? 

Mr. QUARLES. I certainly would not characterize it that way. I 

think it is that we are in early days of what ultimately is a very 

complex problem and a difficult solution, and I think we should not 

approach that solution piecemeal, but should look at what is a comprehensive answer. 

Senator CORKER. So yes or no, are they systemically important? 

Mr. QUARLES. Well, I think it is unarguable that those institutions have systemic consequence. The question is: What is the right 

response to that? 

Senator CORKER. So they are systemically important. Thank you. 

Chairman CRAPO. Senator Jones. 

Senator JONES. Thank you, Mr. Chairman. And thank you, Mr. 

Quarles, for being here. 

I would like to ask you a little bit about something that I am 

hearing more and more about in Alabama, and that is the current 

expected credit loss accounting standard, CECL, that has come in. 

As someone who tries to run away anytime people start talking 

numbers and accounting, I really appreciate what FASB has been 

doing, so I am not making any judgment here. But I am concerned 

in what I hear from our banks a little bit, the concern about unintentional consequences that may impact the ability of banks to 

make long-term loans, whether small business loans or residential 

loans. And I think and my recollection is that in recent comments 

at Brookings, you stated that you believe that there was some 

agreement that CECL was going to be procyclical, but that these 

issues could be addressed as you phased in those rules. 

Can you just expand on those comments a little bit and what you 

are looking at to try to make sure that we do not have those unintended consequences and making sure particularly smaller banks 

are protected? 
12 

Mr. QUARLES. Certainly. So I agree with you that there is a lot 

that we still do not know about how CECL will really operate in 

practice and what the effect will be on banks of any size, but particularly smaller banks. And that is why we had proposed that we 

will have a 3-year phase-in period, at least a 3-year phase-in period, so that we can understand before phasing the CECL results 

into our capital calculations, exactly what those effects are really 

in operation. 

We have gotten a lot of different estimates ex ante as to what 

the consequence will be of CECL. Will there be an immediate increase in reserves on day one? Is the real issue with CECL or the 

real consequence of CECL that there will be procyclicality in the 

event of stress? And if there is procyclicality in the event of stress, 

does that affect banks that are covered by our stress tests? And 

how does CECL work there? And it really is too early to say and 

I do not think we have enough data to know exactly what those 

consequences are going to be, the day one consequences versus the 

ongoing consequences and the stress consequences. 

So we are going to be looking at all of that on the basis of the 

real operation of CECL when it is in effect by delaying our implementation of including it in our capital—— 

Senator JONES. All right. And I assume you will be taking the 

comments. 

Mr. QUARLES. Absolutely. 

Senator JONES. I mean, that phase-in is going to give you the opportunity to tweak, to go back and get comments from the banks 

and how it is going to be—— 

Mr. QUARLES. We will be looking for input from all sources on 

that. 

Senator JONES. All right. Perfect. Thank you for that. 

And so the other thing is the Community Reinvestment Act. I 

think that is going to be one of the most important items that 

banking regulators take up this year. I have spoken to the OCC 

about this. You know, if we get it right, it is going to be really important to modernize the CRA. But if we get it wrong and go in 

the wrong direction, I am concerned still—and I want to make sure 

that this is being addressed—that we are not having different regulators addressing the CRA in different ways. 

So can you give me an update about the Fed’s role working with 

the OCC about trying to modernize the Community Reinvestment 

Act? 

Mr. QUARLES. Certainly. So we have worked with the OCC. The 

OCC has put out an Advance Notice of Proposed Rulemaking, and 

we had extensive discussions, all the banking agencies had extensive discussions together before the OCC went out with that ANPR. 

We will all be looking at the information that comes in as a consequence of that process. We are having a very athletic outreach 

process at the Federal Reserve on questions about the CRA. I think 

we have got 20 different seminars and events that are set up 

throughout the system, throughout our various reserve banks, looking for input on that. And I expect that, moving forward, our expectation is that we will have a joint NPR, Notice of Proposed Rulemaking, at the end of this outreach process that will reflect all the 

information that we receive. 
13 

Senator JONES. Great. Thank you. 

Finally, just a couple of comments. Number one, I know that the 

Fed is part of a working group dealing with anti– money-laundering issues that I know this Committee is likely to take up this 

year. I have been hearing that law enforcement may not be as included on that. I know you have got some. But as a former U.S. 

Attorney, I would just encourage that working group to bring in 

the FBI or other Treasury criminal officials, because there is nothing like boots on the ground to really do that, and I would just encourage you to include some boots-on-the-ground law enforcement 

as part of that working group. 

And the final thing I just want to say is I want to tell you that 

I appreciate very much you and your fellow Fed Board Governors 

for maintaining your independence during a time of recent criticism. I think the independence of the Federal Reserve is truly a 

core bedrock of our economy and our democracy here on both monetary and regulatory policy. It is critical that you maintain that 

independence, so thank you for that. And I want to tell you that 

for as many of us here that we can, we will do what we can to preserve that independence for you. So thank you. 

Mr. QUARLES. Thank you, Senator. 

Chairman CRAPO. Senator Rounds. 

Senator ROUNDS. Thank you, Mr. Chairman. 

Vice Chair Quarles, first of all, thanks for being here. Before I 

get into the questions that I have got for you, I would like to make 

one real quick comment. I would like to echo the remarks made 

yesterday by my colleague from the House Financial Services Committee, Congressman Ted Budd, regarding the insurance regulation. I agree with Congressman Budd that the Fed and other American regulators should stand up for State-based insurance regulation and fight overreach from the international regulators like the 

IAIS, and hopefully you folks will stand strong on that. 

Let me also just jump into where my questions would begin. As 

we conclude the 115th Congress, Americans have a lot of things to 

be thankful for. The postcrisis economic expansion has continued 

for a near record 97 months. Tax reform and the Trump administration’s deregulatory efforts have pushed GDP growth to 4 percent. Unemployment remains at a low of 3.7 percent. These are all 

positive developments. Yet I remain very concerned about a number of troubling economic signals from back home in South Dakota 

with our strong reliance on an ag economy—not just South Dakota, 

but North Dakota, Minnesota, Nebraska, Iowa, the Upper Midwest. 

More specifically, our country’s ongoing trade disputes are causing significant economic problems for my State’s ag economy. As an 

example, the retaliatory tariffs from China on American soybeans 

have caused soybean sales to China to plummet by 94 percent compared to last year’s harvest. 

Now, while the Federal Government’s financial assistance has 

helped to offset some of these losses, the subsidy for each bushel 

of soybeans in some cases covers less than half of the actual loss 

that farmers are facing, and it is the producers that are really taking the brunt. They are on the tip of the spear in this trade dispute. 
14 

The impact, I cannot overemphasize how critical this trade impact is to the economic well-being of farmers in the Upper Midwest. 

In South Dakota, the farm economy is down for 5 years in a row. 

We are down 50 percent in net farm income, and this is not helping 

at this point. And while we see some relief coming, there is going 

to be a time—just as an example, soybeans down by 94 percent 

sales to China, some people say, ‘‘Big deal.’’ China buys 60 percent—of all those that are exported, 60 percent of it goes to China. 

It is close to 30 percent of the entire soybean market. And so this 

is a real impact to farmers in the Upper Midwest. 

Some of these folks, after 5 years of low commodity prices, will 

be coming in to ask for operating loans. The banks in the Upper 

Midwest, those who have survived year in and year out, have over 

the past understood at the local level that every year is not going 

to be a profitable year for an ag operator. And most of those smaller banks that do that expect that some years they are going to 

have to look at something and say, ‘‘You may not have performed 

well last year or commodity prices are down, but we understand 

long term this is going to be a profitable program for our bank, and 

if you do not survive, we do not survive either.’’ 

I am hopeful and what I am asking for is some reassurance from 

the Federal Reserve that the Fed and the FDIC, the regulators and 

the folks who are going to come in and actually audit the banks 

will have an understanding that this short-term trouble we are in 

right now is not going to cost these banks to be identifying these 

ag operators as nonperforming loans if they come back in looking 

for assistance to get by this tough time period in which they are 

on that tip of the spear in this trade dispute. 

Could you comment on that, please? 

Mr. QUARLES. Certainly. I think one of the strengths of our supervisory system is that we have people on the ground with experience both with individual institutions and different categories of institutions and a history of understanding how different markets 

work, and all of that should be brought to bear as they make their 

individual supervisory decisions. 

Senator ROUNDS. I am going to go one step farther because I 

think this is really important. In the previous Administration, 

there were times in which at the upper echelons there was an attempt to get more money out into the economy, and yet at the 

lower echelons, where the actual audits were being done, there was 

a disconnect in that it was very difficult to get the money into the 

ag economy because in some cases specific sections of the ag economy were identified as nonperforming sectors, and even loans that 

had been repaid on time were still being identified as nonperforming assets. 

I just want to hear once again a reassurance that there is some 

sort of a message out there that says that the ag economy is going 

through a tough time; we understand that there can be exceptions 

made, and that we are not going to be punishing the banks for trying to get these folks through a tough time. And that has got to 

come from the top down so that the folks on the front line who are 

doing the audits, making the reviews of the banks, have some understanding about what the banks are trying to do to make sure 
15 

these producers survive and actually continue to help make those 

banks a profit in the future. 

Mr. QUARLES. So I can absolutely commit to you that I take the 

supervision part of this job as important as the regulatory part of 

this job. For what it is worth, as I think you know, I come from 

an agricultural background myself and understand the issues that 

you are talking about, very much so, and will be engaging with the 

supervisors to ensure that they take reasonable decisions. 

Senator ROUNDS. Thank you. 

Thank you, Mr. Chairman. 

Senator BROWN [presiding]. Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. It is good to see you 

again, Governor Quarles. 

I want to follow up on a letter I sent yesterday to the Fed and 

to several other Federal regulators. In it I raised concerns about 

the rapid growth of leveraged corporate lending, that is, lending to 

companies that already have a lot of debt. 

There was a record $1.1 trillion in leveraged loans in the U.S. 

last year, nearly double what it was just a few years ago. In the 

last few weeks, former Fed officials have raised serious concerns 

about the growth of leveraged lending. Former Fed Governor Dan 

Tarullo called for more oversight and transparency because of the 

risks these loans pose to the economy, and former Fed Chair Yellen 

said she is ‘‘worried about the systemic risks associated with these 

loans.’’ 

So do you agree with former Fed Chair Yellen and Governor 

Tarullo that this is a concern? 

Mr. QUARLES. Well, I agree that the framework that they are 

talking about it in, the systemic risk is what it is that we ought 

to be looking at and ensuring that we understand how systemic 

risk is evolving as opposed to simply the volume of leveraged lending. I think that is the right way to look at it. 

Senator WARREN. OK. I understand you think it is the right way 

to look at it. Are you concerned about it, the amount? That is the 

question. 

Mr. QUARLES. Yeah, again, I think the question is what are the 

structures that these loans are being held in. The amount itself is 

not what is critical. What is critical is, you know, are they being 

held in vulnerable structures? Do we understand how the system 

is evolving? And that is something that we are looking at very 

closely. 

Senator WARREN. All I can say, even your fellow Trump appointee, OCC head Joe Otting, said recently that ‘‘there is probably 

a bit more leverage in this market than we as a country should be 

comfortable with.’’ 

So I tell you what, let me move on. In 2013, under the Obama 

administration, the Fed, the OCC, and the FDIC were worried 

about leveraged lending, so they issued joint guidance, and that 

guidance provided risk management and underwriting expectations 

for the leveraged commercial loans, and then they enforced it. The 

next year a dozen banks received notices that they were not following the guidance, and the Fed issued a supervisory finding that 

directed Credit Suisse to abide by the guidelines. 
16 

But things have shifted in the Trump administration. Earlier 

this year, Comptroller Otting said he did not care if the banks 

under his supervision violated the guidelines if it did not affect 

their overall safety and soundness. Is that your position as well? 

Mr. QUARLES. Well, our position with respect to leveraged lending supervision is that we are actually quite athletically looking at 

that. That is something—— 

Senator WARREN. OK, so that is not your position. You are enforcing the guidelines. 

Mr. QUARLES. Well, guidance is guidance. Guidance is intended 

to provide transparency, but it is not something that can be enforceable. It is not a rule. So what we are enforcing are—— 

Senator WARREN. I am sorry. The Fed directed Credit Suisse to 

abide by the guidelines back in 2014, so you cannot say there is 

nothing you can do. The Fed has done it. 

Mr. QUARLES. To enforce guidance is inappropriate. That is not 

something that can be done. 

Senator WARREN. Well, it directed them to follow the guidance. 

I mean, I do not want to split hairs with you. I am just asking a 

question. Are you still holding them to the guidance or not? 

Mr. QUARLES. We are holding them to standards of safety and 

soundness, and I think that is an important distinction, Senator. 

We are not in any way abrogating or not looking at leveraged lending. That is an important part of our supervision. 

Senator WARREN. Are you monitoring compliance with the 2013 

guidelines? 

Mr. QUARLES. We are monitoring compliance with safety and 

soundness. 

Senator WARREN. Is that a no on the 2013 guideline? 

Mr. QUARLES. The guidance is intended to provide transparency 

as to what it is that we will look at. 

Senator WARREN. Are you monitoring compliance with that? 

Mr. QUARLES. We should not monitor compliance with guidance. 

We should monitor compliance—— 

Senator WARREN. I take that as a no, then. 

Mr. QUARLES. ——with safety and soundness. 

Senator WARREN. I will take that as a no. There have been reports of banks offering loans that plainly violate the 2013 guidelines, so it is clear to me that at least the market does not think 

you are monitoring these. What concerns me, Governor Quarles, is 

this market looks a lot like the subprime mortgage market looked 

pre-2008. The loans are badly underwritten with minimal protections. Like subprime mortgages, these loans are being packaged up 

and sold to investors as collateralized loan obligations, or CLOs, 

which spread the risk throughout the system and take the lender 

off the hook for originating a bad loan. And these loans have adjustable rates, which means that if interest rates continue to go up, 

companies will owe more money just at the moment when the overall economy may be slowing down. 

Now, the Fed dropped the ball before the 2008 crisis by ignoring 

the risks in the subprime mortgage market. What are you doing 

differently this time in coordination with other Federal regulators 

so that you are limiting the risk that leveraged loans cause serious 

harm to the financial system? 
17 

Mr. QUARLES. So we are—as I said, it is an important theme of 

our supervision and monitoring—this cycle is monitoring the underwriting standard for leveraged loans. We will be looking at that 

carefully in this supervisory cycle. We are also monitoring carefully 

how the CLO ecosystem is evolving to make sure that we understand where risks are evolving there. 

Senator WARREN. OK. I am not sure that I see much distinction 

between what you are doing now and the Fed was doing pre-2008, 

and I think that is deeply worrisome. I have sent a letter, asked 

more questions in that letter. I hope I will be able to get a response 

soon to that. I am very concerned that the Fed dropped the ball before and may be dropping it one more time on this. 

Thank you. 

Chairman CRAPO [presiding]. Senator Kennedy. 

Senator KENNEDY. Thank you, Mr. Chairman. Good morning, Mr. 

Vice Chairman. 

Can you tell me what exposure, if any, the American banking 

system has to any instability in Italy, including but not limited to 

its banking system? 

Mr. QUARLES. So the exposure of our banking system to Italian 

banks is—the direct exposure is relatively modest. We do not think 

that there is a particular issue there. Obviously it is a single financial sector. There are parts of the European financial sector that 

are exposed to Italy, and we continue to monitor whether developments there could have feedback effects into the United States. We 

are not—we do not view cause for particular concern there at the 

moment. 

Senator KENNEDY. OK. What is a short form call report? 

Mr. QUARLES. The intention of the short form call report is to be 

a form that has less burden on the institutions that fill it out, requires less cost and time, but still provides us all the information 

that we need to ensure that institutions that are less risky are safe 

and sound appropriate to the riskiness. 

Senator KENNEDY. And I believe that Congress and, for lack of 

a better expression, our Dodd–Frank reform bill directed you to 

come up with a short form call report for banks $5 billion or less 

that would be less onerous. Is that right? 

Mr. QUARLES. That is correct. 

Senator KENNEDY. Why haven’t you done that? 

Mr. QUARLES. I know that we are in the process of implementing 

that. I think that—— 

Senator KENNEDY. You promulgated a rule. It is going to save 

the average bank a grand total of 1.18 hours a quarter. The stuff 

that you are cutting out is the stuff that most small banks always 

put zero on. You are not doing anything. I mean, I would like you 

to get in another lick and let us try to be serious about it. 

Refresh my memory what banks $5 billion or less did wrong in 

2008. 

Mr. QUARLES. Well, overconcentration in commercial real estate, 

but we do not believe that they are—— 

Senator KENNEDY. But did they cause—they did not cause the 

meltdown. 

Mr. QUARLES. We do not believe that they are likely to have systemic—— 
18 

Senator KENNEDY. Right, but we punished the hell out of them 

in Dodd–Frank. OK? 

Mr. QUARLES. Yeah, I do believe that it was—that the regulatory 

burden on the smaller banks was too much. 

Senator KENNEDY. I wish you would take another look at your 

promulgated rule. I think it is all hat and no cattle. 

Mr. QUARLES. I appreciate that, and I will go back and look at 

it. 

Senator KENNEDY. OK. Tell me, Mr. Vice Chairman—and I really 

do appreciate the job that you are doing. Tell me what a community bank leverage ratio is. 

Mr. QUARLES. So that is a proposal that we are working on with 

the other regulators to develop standards that a community bank 

that has a certain leverage ratio and other standards would be subject to simplified, much simplified regulation. 

Senator KENNEDY. OK. Would it be fair to say that it would 

mean that a community bank which has a lot of capital, a lot of 

cushion, particularly with respect to or in comparison with the 

larger systemically important banks, would get less supervision? 

Mr. QUARLES. Well, I—— 

Senator KENNEDY. Well, not less supervision. 

Mr. QUARLES. Exactly. 

Senator KENNEDY. Less paperwork. 

Mr. QUARLES. Less paperwork, absolutely. Absolutely. 

Senator KENNEDY. OK. Have you promulgated a rule? 

Mr. QUARLES. We have not promulgated a rule yet, but that is 

one that I expect very soon, and very soon in real time, not Fed 

time. 

Senator KENNEDY. OK. Well, let us suppose that a community 

bank had 6 percent capital. Would you consider that to be well capitalized? 

Mr. QUARLES. Depending on the type of capital, that could be 

well capitalized. 

Senator KENNEDY. OK, with reasonable liquidity. 

Mr. QUARLES. Yeah, I think the community bank leverage ratio 

instruction is somewhere between 8 and 10. We are to look between 8 and 10 percent. 

Senator KENNEDY. Right, 8, 10, 12. I am just saying there are 

a lot of small institutions out there that are very well capitalized, 

and if they belly up, the world is not going to spin off its axis. It 

may for its shareholders, but that is the way capitalism works. 

Mr. QUARLES. Sure. 

Senator KENNEDY. So we really ought to be trying to do everything we can to get a little Government off their back so you can 

concentrate your efforts on banks whose demise could threaten our 

banking system. Would that be fair? 

Mr. QUARLES. I agree. 

Senator KENNEDY. OK. I hope you will do that in developing the 

ratio, and I hope you will take a good second look at that rule that 

I mentioned. Thank you, Mr. Vice Chairman. 

Mr. QUARLES. Thank you, Senator. 

Senator KENNEDY. Have a Happy Thanksgiving. 

Mr. QUARLES. Thank you. 

Chairman CRAPO. Senator Menendez. 
19 

Senator MENENDEZ. Thank you. 

Last week it was reported that more than 500 families, including 

22 in New Jersey, wrongly lost their homes to foreclosure because 

of an error in Wells Fargo underwriting software which caused the 

bank to incorrectly deny mortgage modifications to homeowners. 

That is unacceptable, and there is no amount of remediation or 

apology that makes up for losing your home. 

Now, I know, Mr. Vice Chair, that you have recused yourself 

from matters specific to Wells Fargo, but I do think this raises a 

more serious overarching question about the oversight of the Nation’s biggest banks. I am seriously concerned that we are re-creating a world where homeowners are at the mercy of the banks and 

there will not be a cop on the beat when things go bad. 

So what assurances can you give us that the Federal Reserve is 

specifically monitoring for these types of issues and in a larger 

sense ensuring that homeowners are not subject to the same 

abuses they were during the crisis? 

Mr. QUARLES. So we have a large and active Division of Consumer and Community Affairs where we have regulatory authority 

that remains after the Dodd–Frank Act—and our authority was restricted to some extent as you know, but where we have regulatory 

authority, we have a very active enforcement program in ensuring 

that we are both examining and, where we see deficiencies, enforcing against consumer problems. 

Senator MENENDEZ. And so in this case, that would have been 

lost in that process? Or would something like this be lost in that 

process? 

Mr. QUARLES. So I would not think so. I mean, that is the sort 

of thing that we would look at. I would have to—we can get back 

to you with more specifics. The Fed can get back to you with more 

specifics about Wells Fargo since I am recused, but as a general 

systemic matter, we certainly—we do not underemphasize—— 

Senator MENENDEZ. My point is if you, in fact—I appreciate your 

answer. If you, in fact, are saying that you are looking at systemic 

issues that might affect homeowners in a way that this particular 

instance did, then it did not work as it relates to Wells Fargo. So 

we have to understand what is it that did not work. I would love 

to hear from the Fed the specific about Wells Fargo. But I would 

like to also hear what did not work at the end of the day that did 

not catch this. 

The Federal Reserve recently proposed loosening liquidity rules for banks as large as $700 billion in assets. During the crisis these 

same banks received almost $60 billion in taxpayer bailouts. Liquidity standards are critical to ensuring banks have enough cash 

on hand to meet the demand should there be a stress in the market. The Fed’s proposal, however, would slash those requirements 

and would result in a $77 billion decrease in liquid assets for banks 

with assets of $100 to $700 billion. 

Fed Governor Brainard voted against the proposal saying she 

saw no changes in the financial environment that would require 

the Federal Reserve to substantially weaken such rules. Moreover, 

she said, this proposal comes at the ‘‘expense of an economically 

meaningful increase in the probability of stress at affected institutions,’’ which, in other words, I translate into it is pretty risky. 
20 

How can you justify these changes which put taxpayers at risk 

of future bailouts? 

Mr. QUARLES. So I do not think that they have put taxpayers at 

risk of future bailouts. The effect of our proposed liquidity changes 

would be a reduction in the overall amount of liquidity in the system of between 2 and 2.5 percent. We have since the crisis added 

$3 trillion of liquidity. That is multiples of liquidity than existed 

before the crisis. And these changes to tailor the burden of complying with regulation, according to the riskiness of firms, you 

know, I think are quite appropriate. The firms in that category are 

generally funded with much less wholesale funding. They are much 

less subject to liquidity risk. And yet the overall consequence of 

this change is only 2 to 2.5 percent available liquidity in the system. 

Senator MENENDEZ. Let me talk to that 2.5 percent that you cite. 

My reading of that decline is that it is based on a larger consideration of all liquid assets in the system for banks with more than 

$100 billion in assets. What we are talking about is the decline in 

liquid assets for banks between $100 and $700 billion. So surely 

that ratio is much higher if you consider the liquid assets of the 

institutions who are receiving relief. 

It is estimated that it is a decline of 30 percent for the banks 

over $250 billion in assets and 15 percent for those with assets between $100 and $250 billion. So it is not 2.5 percent. 

Mr. QUARLES. Well, I think the appropriate denominator is the 

system. If you take a subset, you will always get a higher percentage if you take just a subset. But if you look at the system as a 

whole, we are not affecting in any material way the liquidity resources of the system. 

We also are under a statutory instruction to tailor our regulation 

for all firms, and I think this is a way to do that to implement the 

statute without having an important systemic—— 

Senator MENENDEZ. I do not think that statutory instruction is 

one that drives you to ultimately create the potential for greater 

risk as part of that instruction. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you. 

Governor Quarles, that concludes the questioning. We appreciate 

again you taking the time to be here with us today. 

For Senators wishing to submit questions for the record, those 

questions are due on Monday, November 26th, and, Vice Chairman 

Quarles, we ask that you respond promptly to those questions. 

And, once again, thank you for being here. 

Mr. QUARLES. Thank you. 

Chairman CRAPO. This Committee is adjourned. 

[Whereupon, at 11:04 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 
21 

PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO 

Today we will receive testimony from Federal Reserve Vice Chairman for Supervision Randy Quarles regarding the efforts, activities, objectives, and plans of the 

Federal Reserve Board with respect to the conduct, supervision and regulation of 

financial firms supervised by the Federal Reserve Board. 

We last heard from Vice Chairman Quarles in October on the Fed’s progress implementing S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act. 

At that time, the Fed had taken actions to implement some provisions of S. 2155, 

including those related to the 18-month exam cycle, high-volatility commercial real 

estate and the Small Bank Holding Company Policy Statement. 

Since then, the Fed has taken new steps to implement key provisions of the bill. 

Recently, the Fed issued proposals revising the application of enhanced prudential 

standards across four categories of firms to reflect each category’s varying risks. 

These proposals are a step in the right direction, and I appreciate the Fed’s work 

to issue them quickly. 

I understand the amount of staff work that went into getting the proposals out, 

and thank you and your staff for your work on these proposals. 

The proposals would assign banking organizations to one of four categories based 

on their size and other risk-based indicators, including: cross-jurisdictional activity; 

nonbank assets; short-term wholesale funding; off-balance-sheet exposures; and status as a U.S. global systemically important bank, or U.S. G–SIB. 

The category to which an institution is assigned would determine the enhanced 

prudential standards and capital and liquidity requirements to which it would be 

subject. 

I look forward to hearing how the application of certain enhanced prudential 

standards would address the risks associated with cross-jurisdictional activity, 

nonbank assets, short-term wholesale funding and off-balance-sheet exposures. 

The proposal incorporates a number of very positive changes to the current framework for regional banks, including: relief from advanced approaches capital requirements; a reduced liquidity coverage ratio; and changes to the frequency of supervisory and company-run stress testing and, some cases, the disclosure of the results. 

Despite this positive step, the agencies have left a number of items unaddressed, 

including: the treatment of foreign banking organizations; additional details on 

stress testing, including the Fed’s Comprehensive Capital Analysis and Review, or 

CCAR; and resolution planning. 

I encourage the regulators to revisit all regulation and guidance thresholds that 

were consistent with the outdated Section 165 threshold to an amount that reflects 

actual systemic risk. 

Regulators have two options: use a systemic risk factors-based approach, or raise 

all thresholds to at least $250 billion in total assets to be consistent with S. 2155. 

There are also other noteworthy provisions of the bill on which the Fed, working 

with other regulators, has yet to act, including implementation of the Community 

Bank Leverage Ratio and the provision that exempted cash deposits placed at central banks by custody banks from the supplemental leverage ratio. 

The Fed should work promptly to issue proposals to address these critical outstanding issues. 

I was encouraged by Vice Chairman Quarles’ speech last week, particularly the 

emphasis on providing more transparency around stress testing and capital planning processes. 

Finally, last week, all Republican Members of the Banking Committee sent the 

FDIC a letter on Operation Choke Point. 

Operation Choke Point is an initiative in which Federal agencies devised and relied upon a list of politically disfavored merchant categories with the intent of ‘‘choking-off’’ these merchants’ access to payment systems and banking services. 

Staff at the banking agencies use verbal recommendations to encourage banks to 

stop doing business with disfavored, but legal businesses. 

I plan to look into how policy is communicated from the banking agencies to regulated institutions more broadly. 

I appreciate Vice Chairman Quarles’ joining us today to discuss developments in 

the Fed’s supervision and regulation and look forward to hearing more about the 

Fed’s pending work to implement S. 2155. 
22 

PREPARED STATEMENT OF SENATOR SHERROD BROWN 

Thank you, Mr. Chairman and thank you Vice Chairman Quarles for appearing 

before the Committee today. 

The Federal Reserve’s responsibility, and Vice Chairman Quarles’ job, is to ensure 

that the economy works for average Americans—that if you work hard, you can get 

ahead. 

That Wall Street doesn’t again crash the financial system and squander the pensions that families worked their whole lives to earn. 

That banks can’t cheat workers out of their hard-earned savings. 

And that executives are held accountable when they break the law. 

We know the Fed failed in its mission 10 years ago. The Fed had all the power 

it needed to prevent the crash, and its leaders in Washington were too complacent, 

and too cozy with Wall Street, to use their authority to rein in the largest banks 

and protect American taxpayers. 

That’s why immediately after the crash, we put in place rules to strengthen taxpayer protections from big bank risk, and to protect consumers from predatory practices. 

The rules worked—our system got safer, and the rules haven’t stopped banks from 

becoming more profitable than ever. The Fed released a report on Friday showing 

that two important measures of banks’ profitability—return on equity and average 

return on assets—hit a 10-year high in the second quarter of 2018. 

Banks have also reported a 30 percent growth in loan volume since 2013, while 

experiencing a 10-year low in the share of loans that aren’t performing. 

But now, with legislation enacted earlier this year, and the actions of this Administration, we are witnessing—piece by piece—the dismantling of these protections 

for American workers. 

Since the last time Mr. Quarles testified before this Committee, we have two new 

developments that underscore this point. 

First, the Federal Reserve’s proposal to implement the bank giveaway bill, S. 

2155, goes far beyond what the authors of that legislation claimed the bill would 

do. The Fed’s proposed rule loosens protections for banks with more than $250 billion in assets—not small community banks—we’re talking about the Nation’s biggest financial institutions. Combined, these firms hold $1.5 trillion in assets. 

The Fed’s proposal also promises more goodies for the big banks, with rollbacks 

for large foreign banks expected in the next few months. This is despite the fact 

that the Fed’s own progress report said that foreign banks continue to violate anti– 

money laundering laws and skirt Dodd–Frank requirements. 

Second, Vice Chairman Quarles gave a speech last week outlining the Fed’s plans 

for the very largest domestic banks—a speech that could have easily been written 

by one of their lobbyists. 

Mr. Quarles wants to weaken capital requirements for the megabanks, eliminating any leverage capital standards in stress tests. We got a preview of what this 

would look like in June, when the Fed gave passing grades to three banks that had 

clearly failed their stress tests. Now, Mr. Quarles wants to make this year’s giveaway permanent. 

The speech outlined a series of other changes to the Fed’s stress tests that would 

render them essentially meaningless. Mr. Quarles makes no secret of the fact that 

he wants to ease up on the assumptions that guide the tests, wants to eliminate 

portions of the tests, and wants to share with the banks the Fed’s internal models 

against which they are graded—that’s like giving students the answers ahead of 

time. 

These changes, taken alongside the weakening of the Volcker Rule, other big bank 

leverage standards, and an abandonment of nonbank financial oversight, amount to 

gutting the postcrisis protections we put in place to protect American taxpayers future bailouts. 

It’s not just me saying this. Stanley Fischer—the former Vice Chairman of the 

Fed—called these combined rollbacks quote, ‘‘mind boggling’’ and quote ‘‘very dangerous.’’ 

When regulators haven’t finished implementing Dodd–Frank, and the economy 

hasn’t even gone through a full economic cycle, now is not the time to begin dismantling our postcrisis protections. It’s always the same story—Wall Street recovers, 

working families don’t. And when Washington policymakers suffer from collective 

amnesia, working families, savers, and taxpayers end up paying the price. 
23 

1 Board of Governors of the Federal Reserve System, ‘‘Federal Reserve Board Finalizes New 

Supervisory Rating System for Large Financial Institutions’’, news release, November 2, 2018, 

https://www.federalreserve.gov/newsevents/pressreleases/bcreg20181102a.htm. 2 Board of Governors of the Federal Reserve System, Bureau of Consumer Financial Protection, Federal Deposit Insurance Corporation, National Credit Union Administration, and Office 

of the Comptroller of the Currency, ‘‘Agencies Issue Statement Reaffirming the Role of Supervisory Guidance’’, news release, September 11, 2018, https://www.federalreserve.gov/ 

newsevents/pressreleases/bcreg20180911a.htm. 

PREPARED STATEMENT OF RANDAL K. QUARLES 

VICE CHAIRMAN FOR SUPERVISION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE

SYSTEM

NOVEMBER 15, 2018 

Chairman Crapo, Ranking Member Brown, other Members of the Committee, 

thank you for the opportunity to testify on the Federal Reserve’s regulation and supervision of the financial system. My testimony today covers two main topics: our 

efforts to improve regulatory transparency, including the report accompanying my 

submission to the Committee, and our progress in making the postcrisis regulatory 

framework simpler and more efficient. 

The Role of Transparency in Regulation and Supervision 

I am mindful that this semiannual testimony—like my position as Vice Chairman 

for Supervision—is grounded in Congress’s efforts to strengthen and improve the 

Nation’s regulatory framework following the financial crisis. This testimony reflects 

a critical element of those efforts: the desire, and the need, for greater transparency. 

Transparency is part of the foundation of public accountability and a cornerstone 

of due process. It is also key to a well-functioning regulatory system and an essential aspect of safety and soundness, as well as financial stability. Transparency provides financial firms clarity on the letter and spirit of their obligations; it provides 

supervisors with the benefit of exposure to a diversity of perspectives; and it provides markets with insight into the condition of regulated firms, fostering market 

discipline. Transparency increases public confidence in the role of the financial system to support credit, investment, and economic growth. 

The Federal Reserve has taken a number of steps since my last testimony to further increase transparency, and to provide more information about our supervisory 

activities to both regulated institutions and the public. 

For example, the Board recently improved its supervisory ratings system for large 

financial institutions. 1 Ratings are an essential vehicle for supervisory feedback— 

a clear, concise way to convey whether a firm meets expectations, with tangible, predictable consequences for those that fall short. Our ratings system for large institutions had remained unchanged since 2004, even as our supervision of those institutions evolved significantly after the crisis. The new rating system will better align 

ratings for these firms with the supervisory feedback they receive, and will focus 

firms on the capital, liquidity, and governance issues most likely to affect safety and 

soundness. 

The banking agencies also recently clarified that supervisory guidance is a tool 

to enhance the transparency of supervisory expectations, and should never be the 

basis of an enforcement action. 2 Guidance—a valuable tool for examiners to help 

evaluate firms and explain supervisory findings—should always be based on concerns for safety and soundness or compliance at a particular firm. However, guidance is not legally enforceable, and Federal Reserve examiners will not treat it that 

way. 

Finally, we expect shortly to make final a set of measures to increase visibility 

into the Board’s supervisory stress testing program. The enhanced disclosures will 

include more granular descriptions of our models; more information about the design of our scenarios; and more detail about the outcomes we project, including a 

range of loss rates for loans held by firms subject to the Comprehensive Capital 

Analysis and Review. The disclosures will provide a more complete picture of the 

stress testing process, and facilitate thoughtful comments from academics and other 

members of the public, while mitigating the risk of convergence on a single model. 

As a result, we believe the disclosures will improve our work, making the tests more 

reliable, visible, and credible. We will continue our efforts toward greater transparency in stress testing over the next several years, including by disclosing descriptions of additional material models and modeled loss rate disclosures for loan and 

nonloan portfolios. 
24 

3 Board of Governors of the Federal Reserve System, ‘‘Supervision and Regulation Report’’, 

November 9, 2018, www.federalreserve.gov/publications/supervision-and-regulation-report.htm. 4The Federal Reserve is also responsible for timely and effective supervision of consumer protection and community reinvestment laws and regulations. More information about the Federal 

Reserve’s consumer-focused supervisory program can be found in the Federal Reserve’s Annual 

Report to Congress. See section 5, ‘‘Consumer and Community Affairs’’, at https:// 

www.federalreserve.gov/publications/annual-report.htm. The Federal Reserve also publishes the 

Consumer Compliance Supervision Bulletin, which shares information about examiners’ supervisory observations and other noteworthy developments related to consumer protections. See 

https://www.federalreserve.gov/publications/consumer-compliance-supervision-bulletin.htm. 5 EGRRCPA, Pub. L. No. 115-174, 132 Stat. 1296 (2018). 

6 Board of Governors of the Federal Reserve System, ‘‘Federal Reserve Board Issues Interim 

Final Rule Expanding the Applicability of the Board’s Small Bank Holding Company Policy 

Statement’’, news release, August 28, 2018, https://www.federalreserve.gov/newsevents/ 

pressreleases/bcreg20180828a.htm. 7 Board of Governors of the Federal Reserve System, ‘‘Statement Regarding the Impact of the 

Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA)’’, July 6, 2018, 

https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20180706b1.pdf. 8 Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, 

and Office of the Comptroller of the Currency, ‘‘Agencies Propose Rule Regarding the Treatment 

of High Volatility Commercial Real Estate’’, news release, September 18, 2018, https:// 

www.federalreserve.gov/newsevents/pressreleases/bcreg20180918a.htm. 9 Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, 

and Office of the Comptroller of the Currency, ‘‘Agencies Issue Proposal To Streamline Regulatory Reporting for Qualifying Small Institutions’’, news release, November 7, 2018, https:// 

www.federalreserve.gov/newsevents/pressreleases/bcreg20181107a.htm. 

Semiannual Review of the Safety and Soundness of the U.S. Banking System 

The report that accompanies my testimony today is another tool to keep Congress, 

and the public, informed about our work, the banking system, and the role of both 

in supporting the broader economy. 3 The report focuses on the Federal Reserve’s 

prudential supervisory activities. 4 As the report shows, the banking sector remains 

in strong condition, in line with strong U.S. economic performance, with lending 

growth, fewer nonperforming loans, and strong overall profitability. 

Large institutions are well capitalized and liquid, and their capital planning and 

liquidity-risk-management processes are improving. Ninety-nine percent of regional 

and community banks are currently well capitalized, and supervisory recommendations made to smaller firms during the financial crisis have largely been closed. We 

are, however, very much aware of the dangers of complacency, and our report lists 

several priority areas of risk we will continue to monitor closely in the coming year, 

including cyber and information technology risks at supervised firms of all sizes. 

Improvements in Regulatory Efficiency 

Improving regulatory efficiency is another core element of our current regulatory 

efforts. Tailoring regulation and supervision to risk has been a programmatic goal 

of Federal Reserve policy for more than two decades. The motivations are clear: supervisory resources are not limitless, and supervision is not costless, either to the 

public or to supervised institutions. Activities and firms that pose the greatest risk 

should receive the most scrutiny, and where the risk is lower, the regulatory burden 

should be lower as well. 

This principle guided Congress and the Federal banking agencies in designing the 

postcrisis regulatory framework, which imposed greater restrictions on larger, more 

systemically important firms and less intrusive requirements on smaller ones. It has 

also guided our implementation of the Economic Growth, Regulatory Relief, and 

Consumer Protection Act (EGRRCPA, or the Act). 5 On this front, we have made 

substantial progress: 

• expanding eligibility of community banking firms for the Small Bank Holding 

Company Policy Statement, and for longer, 18-month examination cycles; 6

• giving bank holding companies below $100 billion in assets immediate relief 

from supervisory assessments, stress testing requirements, and some additional 

Dodd–Frank Act prudential measures; 7 and 

• implementing changes to liquidity regulation of municipal securities and capital 

regulation of high-volatility commercial real estate exposures. 8

The Board, Federal Deposit Insurance Corporation (FDIC), and Office of the 

Comptroller of the Currency (OCC) have also continued the work to significantly reduce the reporting burden on community banking organizations, altering reporting 

frequencies, items, and thresholds, while preserving the data necessary for effective 

oversight. 9 The agencies recently issued a proposal to reduce further reporting re-
25 

10 Board of Governors of the Federal Reserve System, ‘‘Federal Reserve Board Invites Public 

Comment on Framework That Would More Closely Match Regulations for Large Banking Organizations With Their Risk Profiles’’, news release, October 31, 2018, https:// 

www.federalreserve.gov/newsevents/pressreleases/bcreg20181031a.htm. 11 Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, 

and Office of the Comptroller of the Currency, ‘‘Agencies Propose Rule To Update Calculation 

of Derivative Contract Exposure Amounts Under Regulatory Capital Rules’’, news release, October 30, 2018, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20181030a.htm. 

quirements for small depository institutions in the first and third quarters of the 

year. Under the proposal, around 37 percent of data items would not be required 

in those quarters. 

Our most significant step to implement the Act came 2 weeks ago, when the 

Board issued two proposals to better align prudential standards with the risk profile 

of regulated institutions. 10 These proposals implement changes that Congress enacted this spring in the EGRRCPA. One of the proposals addresses the Board’s enhanced prudential standards for large banking firms, and the other is an interagency proposal amending the regulatory capital and liquidity regulations that 

apply to large banking organizations. Both proposals separate large banking firms 

into four categories, using size as a relevant but not sufficient factor for increased 

regulatory requirements. Among the other factors that will now enter into this assessment are nonbank assets, short-term wholesale funding, and off-balance-sheet 

exposure. The changes would significantly reduce regulatory compliance requirements for firms in the lowest risk category, including most institutions with between $100 billion and $250 billion in assets. Firms with $250 billion or more in 

assets, or firms with assets between $100 billion and $250 billion that meet a risk 

threshold, will face reduced liquidity requirements. The proposals would largely 

maintain existing requirements for the largest and most complex firms. 

These new categories represent a step forward in regulatory efficiency. They draw 

on our experience administering enhanced prudential requirements and other 

postcrisis measures. They recognize that other indicators of risk beyond size are appropriate to consider when determining if more stringent standards should apply to 

certain firms. They move toward a more risk-sensitive, nuanced framework, where 

riskier activities and a larger systemic footprint correspond to higher supervisory 

and regulatory requirements. 

Apart from the requirements of the Act, we also recently proposed a new approach 

to calculating credit risk, known as the standardized approach to counterparty credit risk, or SA–CCR. The new approach would better account for the risks associated 

with derivatives exposures, including market practices that reduce risk, such as netting and initial margin. 11 We issued a proposal simplifying and tailoring requirements under the Volcker rule, to ensure that the most stringent requirements apply 

to the firms with the most trading activity, and that compliance is as simple and 

objective as possible. We also issued a rule limiting the exposure of large firms to 

a single counterparty, addressing a key source of contagion during the financial crisis. We have received thoughtful input from the public that will help inform our implementation of all of these measures. 

Finally, we have continued to engage with supervisors and central banks overseas. The ultimate goal of having an efficient and transparent regulatory system is 

to help the American economy—to enable banking organizations to offer safe, stable 

financial services to households and businesses around the country. But American 

businesses compete in a global marketplace, and as the financial crisis showed, 

when regulatory standards fall in other countries, Americans can pay the price. Engaging overseas, through forums like the Financial Stability Board and the Basel 

Committee on Banking Supervision, helps level the playing field—and it helps ensure that all countries, not just the United States, do their part to maintain and 

protect the global economy. 

Our work to improve regulatory efficiency is not done, and we expect to make additional progress in the months ahead on a number of issues. In particular, we are 

working with our counterparts at the OCC and FDIC on a community bank leverage 

ratio proposal. We expect that this proposal would meaningfully reduce the compliance burden for community banking organizations, while preserving overall levels 

of capital at small banks and our ability to take prompt action when problems arise. 

I look forward to continuing our efforts to make our regulatory framework simpler, more transparent, and more efficient—and I look forward to participating in 

the Committee’s oversight of those efforts. As Chairman Powell said at his swearing-in: ‘‘As a public institution, we must be transparent about our actions so that 
26 

12 Jerome H. Powell, ‘‘Remarks at the Ceremonial Swearing-in’’ (speech at the Federal Reserve Board, Washington, DC, February 13, 2018), https://www.federalreserve.gov/newsevents/ 

speech/powell20180213a.htm. 

the public, through its elected representatives, can hold us accountable.’’ 12 We will 

continue to do so to the best of our ability. 

Thank you, and I look forward to answering your questions. 
27 

SUPERVISION AND REGULATION REPORT—NOVEMBER 2018 
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM RANDAL K. QUARLES 

Q.1. The Fed’s regulation report released on November 9, 2018, 

said that foreign banking organizations (FBOs) still face challenges 

in complying with Dodd–Frank Act enhanced prudential standards 

(EPS). And yet your testimony noted that FBOs can expect a rule 

to ‘‘tailor’’ EPS in the coming year. 

Why would the Fed alter taxpayer protections with regard to 

FBOs when the Fed’s own report says that banks aren’t fully complying with existing requirements? 

A.1. The Board of Governors of the Federal Reserve System (Board) 

has taken, and will continue to take, a risk-based approach to supervision, focusing its resources on those institutions (both domestic and foreign) that pose the greatest risk to safety and soundness 

and financial stability. On October 31, 2018, the Board approved 

two notices of proposed rulemaking that would establish a revised 

framework for applying enhanced prudential standards to large 

U.S. banking organizations based on their risk profiles. The proposals would establish four categories of standards that reflect the 

different risks of firms in each group and would largely keep existing requirements in place for the riskiest and largest firms. The 

proposals build on the Board’s existing tailoring of its rules and experience implementing those rules, and account for statutory 

changes enacted by the Economic Growth, Regulatory Relief, and 

Consumer Protection Act. 

The changes proposed on October 31, 2018, do not apply to foreign banking organizations. As a part of the Board’s current effort 

to develop a tailoring proposal for foreign banks, we are considering the appropriate way to assign foreign U.S. operations to the 

category of prudential standards described in the tailoring proposal 

for domestic firms, in light of the structures through which these 

firms conduct business in the Unites States. 

I expect that this proposal and the two proposed rulemakings 

from October 31, 2018, by applying enhanced prudential standards 

based on risk profile, will enable the Board to continue to apply its 

risk-based approach to supervision in a more effective and efficient 

manner. 

Q.2. In April, the Fed proposed weakening the enhanced supple- mental leverage ratio (eSLR) by $121 billion for the insured depository institutions of the eight largest banks and proposed weakening 

the version of the leverage ratio used in stress tests. In a recent 

speech, you went further, saying that the leverage ratio should be 

eliminated altogether in stress tests. More than half of global systemically important banks (G–SIBs) have had their stock buybacks 

and dividends limited in recent years because the leverage ratio 

was the binding constraint on capital distributions. 

How do you justify letting large banks send capital to shareholders and executives when it could otherwise be protecting taxpayers from bailouts? 

A.2. Postcrisis regulatory reforms, including the supplementary leverage ratio, were designed to improve the safety and soundness 

and reduce the probability of failure of banking organizations, as 

well as to reduce the consequences to the financial system if such 
71 

a failure were to occur. For large banking organizations in particular, the objective of the Federal Reserve Board (Board) has been 

to establish capital and other prudential requirements at a level 

that not only promotes resiliency at the banking organization and 

protects financial stability, but also maximizes long term, throughthe-cycle credit availability and economic growth. In reviewing the 

postcrisis reforms both individually and collectively, the Board has 

sought ways to streamline and tailor the regulatory framework, 

while ensuring that such firms have adequate capital to continue 

to act as financial intermediaries during times of stress. 

Consistent with these efforts, the Board proposed to recalibrate 

the enhanced supplementary leverage ratio (eSLR) to align leverage capital requirements with risk-based capital requirements for 

the G–SIBs. In particular, leverage capital requirements should 

generally act as a backstop to the risk-based requirements. If a leverage ratio is calibrated at a level that makes it generally a binding constraint, it can create incentives for firms to reduce participation in or increase costs for low-risk, low-return businesses. Over 

the past few years, however, concerns were raised that in certain 

cases the eSLR has become a binding constraint rather than a 

backstop to the risk-based standards. With respect to the April 

2018 proposal, a decrease in capital requirements at a subsidiary 

depository institution does not necessarily result in its holding company being able to distribute those funds to shareholders. This happens because the capital rule and other regulatory restrictions at 

the holding company level, such as the Board’s annual stress tests, 

limit the amount of capital that a holding company can distribute 

to shareholders. The analysis that accompanied the April 2018 proposal showed that the banking organizations that would be subject 

to the proposal—global systemically important banking organizations (U.S. G–SIBs)—would be able to release only up to $400 million of tier 1 capital (or approximately 0.04 percent of the amount 

of tier 1 capital held by these firms) to their shareholders. 

With respect to the stress testing program, explicitly assigning a 

leverage buffer requirement to a firm on the basis of risk-sensitive 

poststress estimates, as the stress testing framework is intended to 

do, may be inconsistent with the goals of the leverage ratio. 

Q.3. In a recent comment letter, the Federal Reserve Bank of Minneapolis noted that the ‘‘proposed tailoring of the eSLR and alterations to the existing stress testing that the Board is considering 

will weaken taxpayer protection from bailouts. Recent evidence— 

some of which economists from the Board of Governors itself has 

produced—finds that equity funding requirements for the largest 

banks are too low, not too high. Even measures of the credit cycle 

and financial stability risk indicate that it is likely prudent for 

banks to continue to build capital.’’ 

Please provide your perspective on this statement. 

A.3. Maintaining the safety and soundness of the largest U.S. 

banks is critical to maintaining the stability of the U.S. financial 

system and the broader economy. Accordingly, postcrisis, the Board 

along with the other U.S. banking agencies substantially strengthened regulatory capital requirements for large banks. The Board’s 

capital rules have been designed to significantly reduce the likeli-
72 

1https://www.govinfo.gov/content/pkg/FR-2018-04-25/pdf/2018-08006.pdf 

2See, ‘‘A New Chapter in Stress Testing’’, at https://www.federalreserve.gov/newsevents/ 

speech/guarles20181109a.htm. 

hood and severity of future financial crises by reducing both the 

probability of failure of a large banking organization and the consequences of such a failure, were it to occur. Capital rules and 

other prudential requirements for large banking organizations 

should be set at a level that protects financial stability and maximizes long-term, through-the-cycle, credit availability and economic 

growth. In general, I believe overall loss-absorbing capacity for our 

largest banking organizations is at about the right level. 

More recently, the Board has proposed various regulatory refinements to pursue its long-standing goal of applying prudential 

standards based on a bank’s risk profile and size. This tailoring of 

regulations enables the Board to supervise banking organizations 

in an effective and efficient manner while maintaining their safety 

and soundness. 

Q.4. In a recent speech, you noted that the Fed is going to repropose a rule on its stress testing regime in light of comment letters 

it received. Then your speech goes on to list a whole host of 

changes the Fed may make—each of which is more favorable to the 

banks. 

If the Fed reproposing the Stress Capital Buffer (SCB) proposal 

as you’ve outlined, would G–SIBs be required to hold more or less 

capital relative to the original SCB proposal? 

Can you point us to an example of a proposed change, as noted 

in your speech, which would require G–SIBs to hold additional capital? 

A.4. The Board’s notice of public rulemaking entitled Amendments 

to the Regulatory Capital, Capital Plan, and Stress Test Rules 1

issued in April 2018 would integrate the Board’s regulatory capital 

rules, the Board’s Comprehensive Capital Analysis and Review 

(CCAR), and stress test rules. Under the proposal, the Board’s supervisory stress test would be used to establish the size of a firm’s 

stress capital buffer requirement. As noted in the proposal, the 

stress capital buffer requirement would generally maintain or in 

some cases increase common equity tier 1 capital requirements for 

global systemically important banking organizations (G–SIBs). 

That said, the impact of the proposal on firms would vary through 

the economic and credit cycle based on the risk profiles and 

planned capital distributions of individual firms, as well as the specific severely adverse stress scenario used in the supervisory stress 

test. The same potential impact on individual firms also would 

exist under the changes that I have outlined previously in greater 

detail. 2

Board staff are currently reviewing all comments on the proposal 

and will carefully consider whether any changes to the proposal are 

appropriate. 

Q.5. Does the Fed plan to incorporate the G–SIB surcharge into 

the Comprehensive Capital Analysis and Review (CCAR) for 2019? 

A.5. In 2019, as in past CCAR cycles, the Board intends to evaluate 

each firm’s ability to maintain capital ratios above the poststress 

minimum requirements. The global systemically important bank 
73 

holding company surcharge is not a minimum requirement, and 

thus, would not be considered as part of the CCAR’s quantitative 

assessment. 

We are continuing to evaluate ways to simplify the Board’s capital framework by more closely integrating the regulatory capital 

rules and stress testing. The Board’s proposal, issued in April 2018 

as noted in the response to 4(a), would introduce the concept of 

stress buffer requirements into the regulatory capital rules. This 

proposal would integrate the results of the Board’s supervisory 

stress test into the regulatory capital rules, which already incorporates the G–SIB surcharge. 

The goal of the proposal is to provide a more integrated and cohesive framework that reduces redundancies and inconsistencies 

across the capital rules and stress testing rules. The proposal includes other modifications as well, such as changes to the assumptions used in our stress test. 

Q.6. Will you commit to making your meeting schedule transparent 

so that the Congress and the public can see who you’re talking to 

before the Fed announces any proposed rules changing bank capital, leverage, liquidity, or other standards? 

A.6. In my work as a Federal Reserve Board (Board) Governor, as 

well as the Vice Chair for Supervision and Regulation, I regularly 

meet with a wide range of representatives from the industry, peer 

domestic and foreign regulators, academics, public interest groups, 

and others. These meetings inform me and, in turn, the Board on 

a broad array of critical issues. Consistent with the practice of 

other Board members, I have always provided my calendar to the 

public upon request and will be happy to provide a copy to your 

staff. 

Q.7. You have proposed eliminating the qualitative objection currently included in CCAR. Previously, banks such as Deutsche 

Bank, Santander, Citigroup, HSBC, RBS, Ally, and BB&T have received objections to their capital distribution plans based on qualitative factors. 

What is your justification for eliminating the qualitative objection under CCAR? 

A.7. Capital planning is a core aspect of financial and risk management that helps ensure the financial strength and resilience of a 

firm. Strong, forward-looking capital planning processes ensure 

that large firms have sufficient capital to absorb losses and continue to lend to creditworthy businesses and consumers, including 

during times of stress. 

In 2017, the Federal Reserve eliminated the qualitative objection 

as part of the Comprehensive Capital Analysis and Review (CCAR) 

for large and noncomplex firms, which are generally firms with less 

than $250 billion in assets, in part because of improvements in risk 

management at these firms. I believe that the removal of the qualitative objection for these firms has not diminished the effectiveness 

of supervision. 

Similarly, larger firms have also generally improved their risk 

management in the years since the inception of CCAR. Removing 

the public objection tool and continuing to evaluate firms’ stress 

testing practices through normal supervision for all firms would 
74 

align the outcome of the CCAR qualitative assessment with other 

supervisory programs. Firms would remain subject to the same supervisory expectations, and examiners would continue to conduct 

rigorous horizontal and firm specific assessments of a firm’s capital 

positions and capital planning, tailored to the risk profile of the 

firm. While much of the examination work would center on a firm’s 

capital plan submissions, examination work would continue on a 

year-round basis, taking into account the firm’s management of 

other financial risks. The evaluation of the firm’s capital position 

and capital planning would culminate in a rating of the firm’s capital position and planning. Firms with deficient practices would receive supervisory findings through the examination process, and 

would be at risk of a ratings downgrade or enforcement action if 

those deficiencies were sufficiently material or not addressed in a 

timely manner. 

Q.8. When you were asked about the Community Reinvestment Act 

at a recent House of Representatives hearing, you said that the law 

had become too ‘‘formulaic’’ and that it was therefore less effective. 

If that’s the case, would you oppose the aspect of the OCC’s proposal—which would make the CRA even more formulaic by grading 

banks’ performance according to one simple ratio? 

A.8. I was referring to the fact that, over the years, practices have 

developed among both banks and their supervisors that result in 

much Community Reinvestment Act (CRA) compliance being satisfied with a single type of activity. The drafters of the CRA contemplated, and the language of the statute itself supports, a much 

broader potential for involvement in community development and 

a much wider range of qualifying investments than currently tends 

to result from CRA compliance. We are reviewing information the 

Office of the Comptroller of the Currency has received in response 

to its advance notice of proposed rulemaking on the CRA, as well 

as information gathered through the Federal Reserve’s listening 

sessions at many of the Federal Reserve Banks around the country, 

to determine whether there are steps we might take as regulators 

to come closer to both the letter and intent of the statute. That review is ongoing, and our evaluation of any particular proposal or 

element of a proposal, including any potential measurement standards, will depend on a full analysis of the available information 

upon completion of that review. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM RANDAL K. QUARLES 

Q.1. Section 402 of the Economic Growth, Regulatory Relief, and 

Consumer Protection Act instructed bank regulators to issue a rule 

exempting custody banks’ cash deposits placed at central banks 

from the Supplemental Leverage Ratio calculation. 

When do you expect to implement Section 402? 

A.1. As you indicate, the recent Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) legislation requires 

the Federal banking agencies to amend the supplementary leverage 

ratio as applied to custodial banks. The Federal banking agencies 
75 

are actively working to issue a notice of proposed rulemaking and 

expect to issue it for public comment in the near future. 

The April 2018 proposal to recalibrate the enhanced supplementary leverage ratio standards assumed that the components of 

the supplementary leverage ratio used the capital rule’s existing 

definitions of tier 1 capital (the numerator of the ratio) and total 

leverage exposure (the denominator); however, the definition of 

total leverage exposure will change for certain banking organizations, through the implementation of section 402. As the Federal 

Reserve Board (Board) and the Office of the Comptroller of the 

Currency noted in the April 2018 proposal, significant changes to 

either component of the supplementary leverage ratio would likely 

necessitate reconsideration of the proposed recalibration, as the 

proposal was not intended to materially change the aggregate 

amount of capital in the banking system. Accordingly, staff is evaluating the April 2018 proposal in light of the statutory change, in 

addition to comments received on the proposal. 

Q.2. Holding almost $5 trillion in U.S. banking and nonbanking assets, foreign banking organizations (FBOs) play an important role 

in the U.S. financial system and overall economy. FBOs operating 

within the U.S. and U.S. firms operating abroad should compete on 

a level playing field. For that reason, I was encouraged to learn 

that you intend to review and possibly update regulations applicable to FBOs early in 2019. Previously, you have highlighted Total 

Loss-Absorbing Capital (TLAC) requirements for the intermediate 

holding companies (IHCs) of FBOs as worthy of review. 

Will TLAC requirements be a part of your 2019 efforts? 

If so, what are your plans to tailor and streamline internal TLAC 

and long-term debt requirements? 

A.2. In October 2018, the Board issued notices of proposed rulemaking (NPR) to tailor certain prudential standards for domestic 

banks. The Board plans to develop a separate proposal, for public 

comment, relating to foreign banking organizations (FBOs) and 

their U.S. operations. The October 2018 NPRs did not modify the 

Total Loss-Absorbing Capital (TLAC) requirements for U.S. firms; 

the specific content of a forthcoming FBO tailoring NPR remains 

under consideration. 

Q.3. Finally, are you considering adjusting the January 1, 2019, 

compliance date currently in effect? 

A.3. In the remarks I gave on May 16, 2018, I noted that the Board 

should consider whether the internal TLAC calibration for intermediate holding companies (IHCs) could be adjusted to reflect the 

practice of other regulators without adversely affecting resolvability 

and U.S. financial stability. This matter remains under consideration and the Board continues to monitor relevant developments in 

other jurisdictions. The Board’s rule establishing TLAC, long-term 

debt, and clean holding company requirements for U.S. IHCs of foreign global systemically important banks became effective as of 

January 1, 2019. Any change to the internal TLAC requirements 

for IHCs, or any other aspect of the rule, would need to be adopted 

through the normal public rulemaking process. 
76 

1See https://www.finra.org/industry/update-finra-board-governors-meeting-092618. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON 

FROM RANDAL K. QUARLES 

Q.1. FINRA Rule 4210—Two years ago, I sent a letter to the SEC 

expressing concern about FINRA Rule 4210, which established 

margin requirements on To-Be-Announced (TBA) securities such as 

mortgage-back bonds. The key problem here is that rule 4210 applies to broker-dealers but NOT to banks. Thus broker-dealers can 

use their banking arm to evade this requirement, creating an uneven playing field. Earlier this year, Federal Reserve staff confirmed this ‘‘inequity’’ in a call with my staff. 

Last April, we spoke about this rule in a hearing with this Committee. You promised to review that rule to ensure it did not create 

an unequal playing field between small and medium broker-dealers 

and large, bank-affiliated broker-dealers. I’m sure we agree that restricting market competition isn’t good for anyone except the privileged few banks that would gain business. The day after that hearing, FINRA delayed rule 4210 until March of 2019. 

What steps can the Fed take to ensure that rule 4210 does not 

create an unequal playing field between small and medium-sized 

broker dealers and bank-affiliated broker dealers? Please list them. 

Do you agree that as implemented, rule 4210 creates an unequal 

playing field for the aforementioned financial institutions? 

A.1. As you noted above in your question, the Financial Industry 

Regulatory Authority’s (FINRA) Rule 4210 To-Be-Announced (TBA) 

amendments are not scheduled to be implemented until spring 

2019 at the earliest. In addition, recent action by FINRA suggests 

it is working towards reducing the rule’s burden. For example, in 

September 2018, FINRA’s Board approved revisions to its Rule 

4210 TBA requirements that would eliminate the 2 percent maintenance margin requirement contained in the rule. FINRA’s Board 

also approved revisions that would allow member firms to take a 

capital charge in lieu of collecting margin for mark to market 

losses, subject to specified limitations and conditions. 1 These 

changes would substantially reduce possible inequities between 

FINRA firms and bank dealers. FINRA has not yet sought comment on these revisions, and the Federal Reserve is monitoring 

FINRA’s efforts. If the final result creates an unequal playing field, 

we will work with fellow bank regulatory agencies to address disparities between FINRA firms and bank dealers in this area, taking into account the differences between them. 

Q.2. Mortgage Servicing Assets—As you know, many lenders prefer 

to keep the relationship with the customer via servicing the mortgage, even if the bank sells the mortgage itself. There has been a 

bipartisan view in Congress that the original rule on MSAs, which 

came out as part of the Basel process, was misguided and, indeed, 

punitive as applied to small and midsize banks. Many of us were 

encouraged when the regulators put out a proposal to change the 

existing rule. But that proposal came out over a year ago and still 

nothing has been done to finalize it. The current situation is driving mortgage servicing out of regulated entities and into unregulated ones, which I assume is not your objective. 
77 

2See, e.g., Interagency Statement Regarding the Impact of the Economic Growth, Regulatory 

Relief, and Consumer Protection Act (July 6, 2018), available at https://www.fdic.gov/news/ 

news/press/2018/pr18044a.pdf. 3 83 Fed. Reg. 48,990 (Sept. 28, 2018). 4 82 Fed. Reg. 55,309 (Nov. 21, 2017). The final rule extended the transition provisions for 

banking organizations that are not subject to the capital rule’s advanced approaches. Banking 

organizations subject to the capital rule’s advanced approaches remain subject to the stricter 

requirements beginning on January 1, 2018. 

When can we expect a final rule on mortgage servicing assets to 

be issued? 

A.2. As part of the 2017 Economic Growth and Regulatory Paperwork Reduction Act report, the Board of Governors of the Federal 

Reserve System (Board), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC) 

(collectively, the agencies), and the National Credit Union Administration highlighted their intent to meaningfully reduce regulatory 

burden, especially on community banking organizations, while at 

the same time maintaining safety and soundness and the quality 

and quantity of regulatory capital in the banking system. Consistent with that objective, the agencies issued a proposal in 2017 

to simplify certain aspects of the regulatory capital rules for nonadvanced approaches banking organizations, including a simplified 

treatment for mortgage servicing assets (MSAs) (simplifications 

proposal). 

The agencies are working jointly to implement Economic Growth, 

Regulatory Relief, and Consumer Protection Act (EGRRCPA), 2

which addresses and supersedes aspects of the simplifications proposal. For example, the agencies recently issued a proposed rule to 

conform the regulatory capital treatment of certain acquisition, development, or construction loans to that under EGRRCPA. 3 The 

agencies are actively considering the comments received on the 

simplifications proposal in the context of the changes made by the 

EGRRCPA. 

In addition, on November 21, 2017, the agencies finalized a rule 

to extend the current transition provisions in the capital rules for 

certain capital deductions that would be affected by the simplifications proposal. 4 Thus, while the agencies continue to evaluate comments on the simplifications proposal, for most banking organizations, MSAs not deducted under the capital rules will continue to 

be subject to a 100 percent risk weight rather than the fully 

phased-in 250 percent risk weight. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS 

FROM RANDAL K. QUARLES 

Q.1. In South Dakota, many farmers use derivatives to manage the 

risk of price disruptions due to any number of factors in the marketplace. Given the challenges that farmers are facing on several 

fronts, it’s important that South Dakotans are able to access tools 

like derivatives in a way that’s as cost-effective as possible. 

When our farmers do choose to access derivatives markets 

they’re required to provide margin against their derivative contracts. Banks hold that margin in the event the farmer can’t meet 

their obligations, thereby reducing the risk of default for the bank 

and for the marketplace. 
78 

Unfortunately the Fed’s methodology for the leverage ratio 

doesn’t recognize this reduced risk. As a result, an additional cost 

is imposed on farmers across the country when they hedge against 

price fluctuations. 

When will the Fed act on this issue and provide relief on client 

margin? Farmers are in need of relief wherever they can get it. 

I’m proud to be the Senate sponsor of S. 3577, the Financial Stability Oversight Council Improvement Act of 2018. As we continue 

to look at ways to make our financial system safer and more resilient, it’s important that FSOC also regulates nonbanks based on 

the risk profile of a specific business or industry, not for the sake 

of regulation, and not based only on size. 

Last year the Treasury Department released a report recommending how FSOC can further improve the SIFI designation process for nonbank institutions. Similar to my interest in tailoring regulations, Treasury suggested that an activities-based approach 

would be appropriate. I’m also pleased to hear reports that FSOC 

may be taking action on this front by the end of 2018. 

Can you elaborate on FSOC’s forthcoming proposals? 

If you could, I’d like you to share some of the advantages to the 

activities-based approach that FSOC is considering. 

How will it help the Fed’s work? 

And how will it help the economy more broadly? 

A.1. In October 2018, the Federal Reserve Board (Board), along 

with the Federal Deposit Insurance Corporation (FDIC) and Office 

of the Comptroller of the Currency (OCC) (collectively, the Agencies), issued a proposal that would revise the capital rule to require 

banking organizations to use a more risk-sensitive methodology 

known as the standardized approach for counterparty credit risk 

(SA–CCR) for reflecting derivative contracts in the supplementary 

leverage ratio. The Agencies believe that SA–CCR, which recognizes the shorter default risk horizon applicable to margined derivative contracts, provides a more appropriate measure of derivative 

contracts for leverage capital purposes than does the current approach. Analysis conducted by the Agencies indicates that, compared to the current methodology, the implementation of SA–CCR 

would increase covered banking organizations’ supplementary leverage ratios. 

As noted in the proposal, the Agencies are sensitive to impediments to banking organizations’ willingness and ability to provide 

client-clearing services. The Agencies also are mindful of the Dodd– 

Frank Wall Street Reform and Consumer Protection Act (Dodd– 

Frank Act) mandate to mitigate systemic risk and promote financial stability by, in part, developing uniform standards for the conduct of systemically important payment, clearing, and settlement 

activities of financial institutions. In view of these important, 

postcrisis reform objectives, the Agencies are inviting comment on 

the consequences of not recognizing collateral provided by a clearing member client banking organization in connection with a 

cleared transaction. The Agencies will carefully consider the comments received on the proposal. 

With respect to your second question on the Financial Stability 

Oversight Council (FSOC), the Council has been considering revisions to the interpretive guidance on the designation of nonbanks 
79 

1See https://www.treasury.gov/initiatives/fsoc/council-meetings/Documents/June152018 

lminutes.pdf. 

2See https://www.treasury.gov/press-center/press-releases/documents/pm-fsoc-designationsmemo-11-17.pdf. 3See https://www.federalreserve.gov/publications/files/financial-stability-report-201811.pdf. 

that include taking an activities-based approach (see, for example, 

the minutes of the June 15, 2018, FSOC meeting). 1 Of course, any 

revisions to the FSOC’s current guidance on the designation of 

nonbank financial institutions will have to be approved by the 

FSOC. 

In principle, an activities-based approach toward the designation 

of individual nonbank financial institutions would shift the focus 

toward reviewing potential risks to U.S. financial stability from a 

financial system perspective by examining financial activities and 

products throughout various industries. This approach offers some 

potential advantages, including the consideration of how certain activities undertaken by nonbanks could threaten financial stability 

and how best these threats could be addressed. In addition, such 

an approach could complement the FSOC’s effort to monitor broader vulnerabilities in the U.S. financial system. 

In terms of helping the Federal Reserve’s work, should a firm be 

designated and thus subject to supervision by the Federal Reserve, 

a clear statement from the FSOC of the particular activities of concern could help focus supervisory efforts to limit systemic risk. Further, the activities-based approach proposed in the November 2017 

Treasury Department report 2 could complement the Federal Reserve’s monitoring of financial stability risks. The Board provided 

an overview of the framework it uses to monitor financial stability 

in the November 2018 Financial Stability Report. 3 This framework 

focuses on monitoring vulnerabilities in the financial system, such 

as elevated valuation pressures, excessive leverage within the financial sector, excessive borrowing by businesses and households, 

and funding risks. 

Monitoring of financial vulnerabilities and activities that could 

pose a threat to U.S. financial stability could help regulators design 

policies to reduce the likelihood of financial market disruptions or 

of credit crunches. 

Q.2. Thank you for the ongoing dialogue on the ‘‘standardized approach for measuring counterparty credit risk’’ rule in derivatives 

markets. I appreciate regulators enacting risk-based rules in any 

sector of the economy. 

I understand that the Fed’s goal was to follow the Basel Committee’s approach when it was designing the SA–CCR rule. I also understand that the SA–CCR methodology as designed by the Basel 

Committee recognized that margin posted by derivative users reduces the risk of default. That being said, based on my review of 

the Fed’s SA–CCR rule, I noticed that the Fed omitted the margin 

exposure provisions of the Basel SA–CCR rule. 

One of the purposes of implementing the Basel Committee’s SA– 

CCR rule was to make American companies more competitive with 

our European counterparts, all of whom have implemented the 

Basel-driven version of SA–CCR. 

Why did the Fed choose not to include margin exposure in the 

U.S. SA–CCR rule? 
80 

4See Consultative Document, ‘‘Leverage Ratio Treatment of Client Cleared Derivatives’’, 

Basel Committee on Banking Supervision, October 2018, available at https://www.bis.org/bcbs/ 

publ/d451.pdf. 

Will this lack of recognition on margin perpetuate the disparities 

between the U.S. and Europe and put our financial institutions at 

a disadvantage? 

A.2. The proposal is generally consistent with the Basel Committee’s standards on the recognition of margin in the risk-based and 

leverage capital frameworks. In particular, the proposal to require 

use of SA–CCR in calculating the supplementary leverage ratio is 

generally consistent with the Basel Committee’s standard on leverage capital requirements, which currently limits collateral recognition. The Agencies are sensitive to impediments to firms’ willingness and ability to provide client-clearing services, and recognize 

the wide support for the migration of derivative contracts to central 

clearing frameworks. In particular, in October 2018, the Basel 

Committee issued a consultative document seeking views on 

whether to recognize collateral in their leverage capital requirement. 4 Accordingly, the Agencies are inviting comment on the consequences of not recognizing collateral provided by a clearing member client banking organization in connection with a cleared transaction. The Agencies will carefully consider each comment on the 

proposal. 

Q.3. As you know, Section 402 of S. 2155 exempted the cash deposits of custody banks held at central banks from the supplemental 

leverage ratio. 

Can you give us an update on when section 402 will be implemented? 

And can you shed a bit more light into how this section of the 

law will interact with changes to the supplemental leverage ratio 

that the Fed announced back in April? 

Balancing these two priorities is important given that regulatory 

changes announced in April could potentially blunt the impact of 

S. 2155. 

A.3. As you indicate, the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) requires 

the Federal banking agencies to amend the supplementary leverage 

ratio as applied to custodial banks. The Federal banking agencies 

are actively working to issue a notice of proposed rulemaking and 

expect to issue it for public comment in the near future. 

The April 2018 proposal to recalibrate the enhanced supplementary leverage ratio standards assumed that the components of 

the supplementary leverage ratio used the capital rule’s existing 

definitions of tier 1 capital (the numerator of the ratio) and total 

leverage exposure (the denominator); however, the definition of 

total leverage exposure will change for certain banking organizations through the implementation of section 402. As the Board and 

OCC noted in the April 2018 proposal, significant changes to either 

component of the supplementary leverage ratio would likely necessitate reconsideration of the proposed recalibration, as the proposal 

was not intended to materially change the aggregate amount of 

capital in the banking system. Accordingly, staff is evaluating the 

April 2018 proposal in light of the statutory change, in addition to 
81 

5See https://www.federalreserve.gov/newsevents/pressreleases/bcreg20181031a.htm. 

comments received on the proposal. The Board also plans to implement the requirements of section 402 in the near-term. 

Q.4. I’ve reviewed remarks you gave at the Brookings Institution 

on November 9th and appreciate efforts you’re undertaking to implement S. 2155 by tailoring capital and liquidity for banks based 

on risk. As the Senate lead on S. 366, the TAILOR Act, I appreciate any and all steps our banking regulators take to tailor regulations to the risk profile and business model of a given institution 

as opposed to regulating based on arbitrary asset thresholds. 

During your remarks at Brookings you stated that S. 2155 did 

not provide relief for large banks and that after the Fed finalizes 

its tailoring proposal it will turn its focus to other parts of our regulatory system. 

Can you shed a bit more light into what you meant by that? 

What issues will you be considering in your efforts to bring 

greater efficiency to our regulatory system? 

A.4. The proposals approved by the Board for public comment on 

October 31, 2018, are designed to efficiently tailor prudential 

standards to the risks of large U.S. banking organizations while ensuring that firms maintain sufficient resources and risk management practices to be resilient under a range of economic conditions. 5 The proposals build on the Board’s existing tailoring of its 

rules and experience implementing those rules, and account for 

changes made by the EGRRCPA to the enhanced prudential standards requirements under section 165 of the Dodd–Frank Act. 

In the proposals, the Board stated its plans to propose at a later 

date similar amendments that would tailor capital planning and 

resolution planning requirements for large U.S. banking organizations. The Board also stated its plans to issue a separate proposal 

relating to foreign banking organizations that would implement 

section 401 of the EGRRCPA for these firms, take into account the 

structures through which these firms conduct business in the 

United States and reflect the principles of national treatment and 

equality of competitive opportunity. 

In addition, the Board in general aims to reduce unnecessary 

costs associated with and streamline regulatory requirements 

based on its experience implementing the rules and consistent with 

the statutory provisions that motivated the rules. 

Q.5. The June 2017 Treasury Report on banks and credit unions 

recommended, ‘‘The application of U.S. enhanced prudential standards to foreign banking organizations (FBOs) should be based on 

their U.S. risk profile, using the same revised threshold as is used 

for the application of the enhanced prudential standards to U.S. 

bank holding companies, rather than on global consolidated assets.’’ 

How will the Federal Reserve tailor its regulations according to 

this recommendation and the longstanding principle of national 

treatment? 

A.5. The Board is in receipt of the June 2017 Department of Treasury report and has carefully reviewed its contents including its recommendations. As noted above, the Board is considering the appro-
82 

priate way to assign the U.S. operations of foreign banking organizations to the categories of prudential standards described in the 

Board’s October 31, 2018, proposal to tailor prudential standards 

for domestic firms, in light of the special structures through which 

these firms conduct business in the United States. 

Q.6. Given that foreign regulators may retaliate against American 

institutions for overly aggressive actions taken by U.S. regulators, 

what steps will the Federal Reserve take to focus its tailoring on 

the risk profile of intermediate holding companies and not the 

branch networks of international banks, which are subject to regulation by their home countries? 

A.6. In developing a proposal for foreign banking organizations, the 

Board will consider the special structures through which these 

firms conduct business in the United States. The Board’s current 

enhanced prudential standards were designed to increase the resiliency of the U.S. operations of foreign banking organizations, including the U.S. branches and agencies of these firms. In developing the proposal, the Board will continue to consider the principles of national treatment and equality of competitive opportunity 

along with the extent to which a foreign banking organization is 

subject, on a consolidated basis, to home country standards that 

are comparable to those applied to financial companies in the 

United States. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TILLIS 

FROM RANDAL K. QUARLES 

Q.1. After Nasdaq became an exchange in 2006, it is my understanding that the Federal Reserve has not undertaken any effort 

to update its rules to provide a pathway to margin eligibility for 

companies traded over-the-counter (OTC). Margin eligibility of 

OTC-traded stocks can be an important part of the growth of small 

and emerging companies, as it helps to improve the market quality 

of those securities, impact an investor’s willingness to purchase 

those securities, and as a result have a direct impact on capital formation. In addition, U.S. investors in the American depositary receipts (ADR) for Roche ($10bn yearly net income) and other large, 

international OTC traded firms are also negatively impacted by the 

Federal Reserve’s inaction on this issue. 

Will the Federal Reserve take action to revive the margin list for 

certain OTC securities? If not, please explain why. 

A.1. Responding to your question above and as previously posed regarding the List of Over-the-Counter Margin Stocks (OTC List) 

that is no longer published by the Federal Reserve Board (Board), 

staff have continued to monitor OTC market developments in the 

years since the publication of the OTC List ceased. Any expansion 

of the types of securities that are margin eligible would require 

careful consideration by the Board of the benefits of such an approach weighed against potential increased burden on banks and 

other lenders. 

Please know that I appreciate your concerns as noted in your 

questions, and we are looking into potential approaches that may 

be considered while ensuring any changes would not pose addi-
83 

tional regulatory burdens. By way of background, I am including 

a brief summary of the history of the Board’s OTC List. 

In 1968, Congress amended section 7 of the Securities Exchange 

Act of 1934 (SEA) to allow the Board to regulate the amount of 

credit that may be extended on securities not registered on a national securities exchange, or those securities known as ‘‘over-thecounter’’ or ‘‘OTC’’ securities. The following year, the Board adopted 

criteria to identify OTC stocks that have ‘‘the degree of national investor interest, the depth and breadth of market, the availability 

of information respecting the security and its issuer, and the character and permanence of the issuer’’ to warrant treatment similar 

to equity securities registered on a national securities exchange. 

The Board’s first periodically published OTC List became effective 

on July 8, 1969. 

In 1975, Congress further amended the SEA to direct the Securities and Exchange Commission (SEC) to facilitate the development 

of a ‘‘national market system’’ (NMS) for securities to accomplish 

several goals, including price transparency. The SEC’s criteria for 

NMS securities came to cover both exchange-traded stocks (which 

were always marginable) and a subset of stocks traded on Nasdaq, 

the largest and most technologically advanced over-the-counter 

market at that time. The majority of the securities traded on 

Nasdaq’s NMS tier were covered by the Board’s OTC margin stock 

criteria and appeared on the Board’s OTC List. The Board’s analysis, however, indicated that the liquidity and other characteristics 

of NMS securities generally compared favorably with those of exchange-traded securities. Accordingly, the Board amended its margin regulations in 1984 to give immediate margin status to OTC securities that qualified as NMS securities without regard to whether 

the stock appeared on the Board’s OTC List. This action established a precedent for relying on NMS status under SEC rules as 

a substitute for identifying margin-eligible OTC securities through 

the application of Board established criteria. 

The Board ceased publication of its OTC List in 1998, and provided margin status to all securities listed on the Nasdaq Stock 

Market, after Nasdaq raised the listing standards for non-NMS securities trading on its market, making them comparable to those 

traded on national securities exchanges. Indeed, Nasdaq subsequently became a national securities exchange. 

Q.2. In previous reports on the state of supervision and regulation, 

you have stated, ‘‘the Federal Reserve relies to the fullest extent 

possible’’ on State insurance departments in the supervision of Insurance Savings & Loan Holding Companies (ISLHC) and that you 

have worked closely with State officials and the National Association of Insurance Commissioners (NAIC) to maximize supervisory 

efficiencies and avoid duplication. I continue to hear from my constituents and insurance companies in my State that ‘‘tailoring’’ is 

not occurring. It is difficult to point to a single specific action the 

Federal Reserve has taken to tailor for these companies, and they 

continue to exit the business of banking, with several exits in the 

last year. 

Is the Federal Reserve concerned about this trend? 
84 

1 Capital Requirements for Supervised Institutions Significantly Engaged in Insurance Activities, 81 Fed. Reg. 38,631 (June 14, 2016), https://www.federalregister.gov/documents/2016/06/ 

14/2016-14004/capital-reguirements-for-supervised-institutions-significantly-engaged-in-insurance-activities. 

What specific further actions will the Federal Reserve take to 

make sure that ISLHCs are not being driven from the business of 

banking by inefficient and overly burdensome regulation? 

A.2. In supervising insurance savings and loan holding companies 

(ISLHCs), the Federal Reserve has aimed to develop policies that 

are insurance-centric and appropriate for the insurance business 

and regulatory environment. For instance, the Board’s advance notice of proposed rulemaking on insurance capital requirements set 

out two frameworks for capital standards that are each unlike the 

Board’s capital rules for bank holding companies. 1 The Federal Reserve recognizes that ISLHCs have multiple functional regulators 

and that State insurance regulators are the primary functional supervisors of the insurance companies. In supervising the consolidated insurance organization, the Federal Reserve remains committed to working cooperatively with State insurance regulators to 

reduce the potential for duplication and undue burden of supervisory activities. The Federal Reserve also tailors its supervisory 

activities and guidance to account for the unique characteristics, 

organizational and regulatory structures associated with ISLHCs. 

Examples of tailoring for these companies include the Board’s exemption of ISLHCs from Federal Reserve consolidated capital, 

stress testing and liquidity rules which are generally applicable to 

banking organizations. 

Federal Reserve examination teams rely on State insurance regulators to the fullest extent possible for the assessment of insurance 

risks and activities. For example, supervisory evaluations and findings from State insurance regulators are incorporated into the Federal Reserve’s consolidated supervision assessments. Federal Reserve examiners defer to State insurance regulators for the evaluation of insurance activities pertaining to insurance underwriting, 

reinsurance, reserving, market conduct, and compliance with State 

insurance laws. 

The Federal Reserve also coordinates with State insurance regulators through information sharing agreements and supervisory colleges. Additionally, Federal Reserve examination staff meet with 

each ISLHC’s primary State insurance regulators to share supervisory information (e.g., inspection reports, supervisory plans), coordinate supervisory activities, and identify opportunities to leverage each agency’s work to complement supervisory efforts and 

avoid duplication. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN 

FROM RANDAL K. QUARLES 

Q.1. You recently made a speech about the Federal Reserve’s 

‘‘Stress Capital Buffer’’ proposal, which makes significant changes 

to the annual supervisory Comprehensive Capital Analysis and Review (CCAR) administered by the Fed. You indicated that the Fed 

would make a second proposal in response to some industry comments. 
85 

According your remarks, the Fed is considering allowing a firm 

to develop a capital distribution plan after its stress tests because 

‘‘firms have told us that they would be able to engage in more 

thoughtful capital planning if they had knowledge of that year’s 

stress test results before finalizing their distribution plans for the 

upcoming year.’’ 

What evidence has the Fed received that firms will actually be 

more thoughtful rather than simply plan to distribute the maximum amount permitted by the stress tests, thereby outsourcing 

their capital decisions to the Fed? 

A.1. Currently, and under the Stress Capital Buffer proposal, a 

firm must decide whether to increase or decrease its planned dividends and share repurchases for the upcoming year without knowledge of a key constraint: the results of the stress test. While this 

practice is intended to encourage firms to think rigorously about 

their capital uses and needs in developing their capital plans, it 

also introduces significant uncertainty into a firm’s capital planning process. 

Adjusting the operation of the rule such that firms know their 

stress capital buffer before they decide on their planned distributions for the coming year would remove this uncertainty. This 

change would not change the expectation that firms continue to engage in meaningful capital planning and use their internal capital 

planning processes to set their planned capital distributions. The 

Federal Reserve would continue to use the supervisory process to 

evaluate the strength of each firm’s capital planning process, including identifying its material risks and determining the capital 

necessary to withstand those risks during stressful conditions. 

Q.2. You indicated in your speech that ‘‘reducing volatility’’ of 

stress test demands would be the goal of a future proposal. The 

purpose of a stress test is to determine how a firm will fare under 

an unanticipated shock. 

How is a goal of reducing or minimizing changes in stress test 

results to avoid ‘‘management challenge’’ to banks compatible with 

this purpose? 

A.2. The supervisory stress test allows the Federal Reserve to assess the resilience of banking organizations under various economic 

stress scenarios. It is essential to the continued success of the 

stress test as a supervisory tool that we preserve the dynamism of 

the stress test, and we seek to balance this objective with other supervisory objectives in evaluating future proposals. 

One of these supervisory objectives is to mitigate excessive volatility in stress test results. It is typical for supervisory stress test 

results for a given firm to change year-over-year, as the scenarios 

and firms’ portfolio characteristics change, and we want to maintain that feature. 

However, large changes in year-over-year stress test results, particularly those not driven by portfolio changes, can make it difficult 

for firms to engage in responsible capital planning. 

Maintaining the dynamism of the supervisory stress test need 

not be at odds with mitigating excessive volatility in supervisory 

stress test results. We are in the process of carefully considering 
86 

how to achieve an appropriate balance of these two goals in future 

proposals. 

Q.3. The 2008 crisis created financial stress because firms were not 

anticipating significant losses from mortgage-backed securities, 

which were assumed to be relatively safe assets until unanticipated 

losses rapidly materialized over the 2007–2008 period. Over that 

period banks were permitted to return about a hundred billion in 

capital to shareholders, which later had to be made up by taxpayers through public capital injections. 

How will a low-volatility stress test effectively require banks to 

preserve capital during such sharp turns in the market? 

A.3. Mitigating excessive volatility in loss estimates, and estimates 

of poststress capital, need not be synonymous with maintaining a 

static stress test that does not take emerging risks into the economic and financial environment into account. 

Indeed, it is essential to the continued success of the stress test 

as a supervisory tool that we preserve the dynamism of the stress 

test, and we seek to balance this objective with other supervisory 

objectives in evaluating future proposals. 

The severely adverse scenario used in the Board’s annual stress 

test reflects a sharp deterioration in macroeconomic and market 

conditions, similar to what we experienced during the 2007–2008 

period. 

Several elements of the Federal Reserve’s stress testing and scenario framework are geared toward capturing shifts in the economic environment and in firms’ risk profiles. These types of shifts 

would continue to be captured in the supervisory stress test results. Specifically, supervisory models are regularly reestimated 

with newly available data, and the Board’s scenario design framework allows for the incorporation of salient risks to the current economic outlook. Further, the Federal Reserve’s supervisory modeling 

policies seek to limit reliance on past outcomes, so that supervisory 

models can incorporate events or outcomes outside of historical experience. 

Q.4. You also indicated that the Fed would begin to ‘‘disclose additional detail about supervisory stress tests models and results . . . 

allow[ing] firms to benchmark the results of their own models 

against those of the supervisory models.’’ 

Won’t a lower-volatility stress test in which details of models and 

assumptions are widely known result in a system where stress 

tests are functionally equivalent to the Basel III risk-based capital 

rules? If so, what would be the justification for having multiple systems of risk-based capital? 

A.4. Maintaining the dynamism of the supervisory stress test—and 

therefore its distinction from the Basel III risk-based capital 

rules—is one of our key objectives, and need not be at odds with 

mitigating excessive volatility in supervisory stress test results. Supervisory stress test results for a given firm will continue to change 

year-over-year, as the scenarios and firms’ portfolio characteristics 

change. We seek to reduce potentially excessive changes in yearover-year stress test results, which can make it difficult for firms 

to engage in responsible capital planning. 
87 

We believe that the additional model disclosures that we proposed late last year appropriately increase the degree of transparency into supervisory models while preserving the dynamism of 

the exercise. 

In evaluating future proposals, we will continue to consider how 

best to achieve an appropriate balance of the objectives of mitigating excessive volatility in capital requirements and preserving 

the dynamism of the stress test exercise. 

Q.5. The Fed is apparently also considering seeking the public’s 

‘‘input on scenarios and salient risks facing the banking system 

each year,’’ providing another opportunity for interested parties to 

shape the stress tests. Under the current framework, the scenarios 

are determined by the Fed’s economists, with input from the reserve banks. 

Have you lost confidence in the ability of these experts to foresee 

risks and develop effective stress test scenarios? If not, what is the 

value of allowing industry actors to influence the tests they will receive? 

A.5. The stress test provides a forward-looking measurement of 

bank capital, a view of common and systemic risks across the banking sector, and a broader understanding of the health of the financial system. By helping us ensure that the largest firms have sufficient capital to absorb losses and continue to lend in stressful conditions, the stress test helps to reduce the potential that distress 

from a single large firm will spill over to the broader economy. The 

results are valuable for markets, analysts, and ultimately, the participating firms. 

The Federal Reserve Board’s (Board) supervisory stress test independently assesses the resilience of the financial system under 

stress. I believe that our ability to provide an independent view of 

capital adequacy enhances the credibility of the test and of our supervisory program. Our independent assessment of poststress capital relies on models and scenarios developed by Federal Reserve 

staff, which is comprised of a wide range of experts that drive innovation in their fields. Across the Federal Reserve System, our diverse workforce publishes a wide range of economic and policy research and plays an active role in academic discourse. 

Yet we recognize that we are not, and cannot be, a monopoly on 

insight and wisdom. In the past, the Board has sought and benefited from multiple and diverse perspectives on elements of its 

stress testing program. For example, the Board recently invited 

public comment on principles governing stress test model design 

and amendments to further clarify the scenario design framework. 

Through that process, we received valuable feedback which we incorporated in the finalized amendments. 

We will continue to push the frontier of stress testing, through 

our own research and through the insights we gain from our engagement with the public. We recently announced that we will host 

a stress testing conference in July that will be open to the public. 

During the conference, we expect that a number of diverse stakeholders, including academics, public interest representatives, and 

financial sector representatives, will share their thoughts on cer-
88 

1https://www.govinfo.gov/content/pkg/FR-2018-04-25/pdf/2018-08006.pdf 

tain aspects of the stress test program, including our current approach to scenario design. 

Q.6. In the recent stress capital buffer (SCB) proposal, you shifted 

the stressed leverage ratio requirement from the supplemental leverage ratio to the less stringent Tier 1 leverage ratio. In your recent speech you then proposed to eliminate the stressed leverage 

ratio requirement altogether. You justified elimination of this requirement by claiming that including the leverage ratio in the 

stress tests made the operational effect of the leverage ratio more 

dependent on modeled risks. 

But won’t eliminating the stressed leverage ratio altogether significantly increase the role of risk modeling and risk weights in the 

capital system? 

Could you please provide information on how many firms experienced the current stressed leverage ratio requirement to be their 

binding or most significant constraint in the stress test process? 

A.6. The Board’s notice of public rulemaking entitled Amendments 

to the Regulatory Capital, Capital Plan, and Stress Test Rules 1

issued in April 2018 sought comment on the introduction of a 

stress leverage buffer requirement in addition to the current capital rule’s 4 percent minimum tier 1 leverage ratio requirement. 

However, the stress buffer concept would not be extended to the 

supplementary leverage ratio. Our analysis indicates that the 

stressed supplementary leverage ratio was the binding constraint 

for one firm based on the results of the Comprehensive Capital 

Analysis Review 2018. 

Leverage ratios are intended to function as a backstop to traditional risk-based capital requirements. Whether or not there is an 

additional stress leverage buffer, global systemically important 

banks would continue to remain subject to the capital rule’s enhanced supplementary leverage ratio standards so leverage capital 

requirements would continue to serve as a strong backstop. Board 

staff are currently reviewing all comments on the proposal and will 

carefully consider whether any changes to the proposed stress leverage buffer requirement or more generally are appropriate. 

Q.7. Your remarks also indicated that you were motivated by the 

view that the ‘‘[t]ransparency of the stress test and its inputs and 

outputs is key to the credibility of the stress test.’’ 

Does the Fed have any evidence that firms or the market aren’t 

taking stress tests seriously under the current regime? 

A.7. The Federal Reserve’s stress test remains an effective supervisory tool. We believe it is important to seek public input and to 

assess ways to further enhance the test’s effectiveness. 

Since the inception of the supervisory stress test, the Board has 

gradually increased the breadth of its public disclosure. By increasing the amount of information about the assessment that is available to the public, the Board has invited the public to engage and 

make an independent evaluation of the stress test’s soundness. 

Since the supervisory capital assessment program exercise in 2009, 

incremental disclosures of supervisory models and results have 

benefited banking organizations and those seeking to understand 
89 

the resilience of firms in times of economic stress. The December 

2017 proposals to increase transparency of the supervisory stress 

test are the latest incremental step to increase disclosure. 

In evaluating each incremental disclosure, the Board considers 

how to disclose information about the stress tests in a manner that 

appropriately balances the costs and benefits of transparency. For 

example, we have not disclosed the full details of our models, in 

large part due to the Board’s concerns about convergence of stress 

testing, which would make them less effective and would undermine the financial stability gains we have made. We also seek to 

guard against the risk of firms making modifications to their businesses that change the results of the stress test without changing 

the risks they face. This behavior could result in the stress test giving a misleading picture of the actual vulnerabilities faced by 

firms. It could also result in all firms increasing their holdings of 

assets that perform better in the supervisory stress test, which 

would make the financial system as a whole less diversified and 

more vulnerable to shocks. 

RESPONSES TO WRITTEN QUESTIONS OF 

SENATOR CORTEZ MASTO FROM RANDAL K. QUARLES 

Q.1. Wells Fargo—Wells Fargo Bank admitted to creating more 

than 3.5 million accounts without customers’ authorization. Wells 

Fargo forced hundreds of thousands of automobile loan customers 

to pay for unnecessary insurance policies, with the added expense 

leading some borrowers to default and lose their vehicles. Wells 

Fargo also admitted to charging improper fees to some mortgage 

borrowers. Wells Fargo did not offer help to 870 mortgage borrowers that they were entitled; 545 of those borrowers had their 

homes taken from them in foreclosure proceedings. Three of them 

were from Nevada. 

In February, the Federal Reserve cited those and other issues 

when it ordered the bank to halt expansion until it can prove to 

regulators that it has systems in place to prevent consumer abuses. 

What issues remain with Wells Fargo leadership’s remediation 

plan? 

Will the Fed object to Wells Fargo capital distribution plan until 

a remediation plan has been accepted and the consent decree released? 

Why did the Federal Reserve not use the Comprehensive Capital 

Analysis and Review process to object to Wells Fargo’s capital distribution plan? 

A.1. Thank you for your question. Please note that I have recused 

myself from participating in official matters specific to Wells Fargo, 

as detailed in a press release dated December 15, 2017. 

Q.2. The most recent news from Wells Fargo—870 mortgage borrowers not appropriately assisted—more than 500 wrongly foreclosed on—was reported AFTER the consent order was signed in 

February. 

Should we expect more problems of unfair, deceptive and abuse 

practices harming Wells Fargo’s customers in the coming year? 

Does the Fed and other banking regulators feel they have a handle 

on the harmful practices at Wells Fargo? 
90 

A.2. Please see my response to Question 1. 

Q.3. Is the asset cap the Fed put in place adequate for changing 

Wells Fargo’s behavior? 

A.3. Please see my response to Question 1. 

Q.4. The Supervisory Reports states that that sales practices and 

incentive-based compensation is an area of priority. [p.27] 

What will the Fed do to change incentive pay and sales practices 

at banks? 

A.4. As noted in the Federal Reserve Board’s (Board) November 

2018 Supervision and Regulation Report, the Board conducted reviews of sales and incentive compensation practices at certain State 

member banks with total assets between $10 billion and $50 billion. The reviews identified acceptable practices. When exceptions 

were noted, however, findings were determined to be correctable in 

the normal course of business. 

Through our existing supervisory process, we will continue to 

monitor firms’ progress towards appropriately balancing risks concerning sales and related incentive compensation practices. 

Q.5. What is the status of the Incentive-based compensation rule 

mandated by the Dodd–Frank Wall Street Reform and Consumer 

Protection Act? I would note that this is a mandatory law, not discretionary. 

A.5. In June 2016, the Board, Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), 

the Securities and Exchange Commission (SEC), the National 

Credit Union Administration (NCUA), and the Federal Housing Finance Agency (collectively, the agencies), jointly published and requested comment on a proposed rule under section 956 of the 

Dodd–Frank Wall Street Reform and Consumer Protection Act. 

This joint effort proposed several requirements to address incentive 

compensation arrangements. The agencies received over 100 comments on the proposed rule. Development of a final rule on an 

interagency basis in light of those comments is now under active 

work by the agencies. 

The Federal Reserve continues to evaluate incentive compensation practices as a part of ongoing supervision. This supervision 

has focused on the design of incentive compensation arrangements; 

deferral and risk adjustment practices (including forfeiture and 

clawback mechanisms); governance; and the involvement of the 

firm’s controls and control function groups in various aspects of incentive compensation arrangements. 

The Board’s supervision focuses on encouraging robust risk management and governance around incentive compensation practices 

rather than prescribing amounts and types of pay and compensation. 

Q.6. Bank Secrecy Act/Anti– Money Laundering—In the Fed’s Supervisory Report released last week, you note that of the supervisory findings currently outstanding, nearly 20 percent relate to 

weaknesses in BSA/AML programs. [p.26] 

Can you be more specific about how ‘‘machine-based learning’’ 

could help banks more easily comply with the Bank Secrecy Act? 
91 

1See https://www.federalreserve.gov/newsevents/pressreleases/bcreg20181203a.htm. 

A.6. Some banks are becoming increasingly sophisticated in their 

approach to Bank Secrecy Act/Anti– Money Laundering (BSA/AML) 

compliance, and machine learning features prominently among the 

types of new technology that banks have been exploring in recent 

years. Machine learning can have many different applications, for 

example, some banks have experimented with this technology as a 

way to identify potentially suspicious patterns in transaction data 

at a reduced cost to the institution. While machine learning has 

the potential to enhance suspicious activity monitoring and other 

BSA/AML compliance processes, the use of this technology is at an 

early stage. The Federal Reserve does not advocate a particular 

method to comply with the BSA and believes that, as a general 

matter, institutions should consider a broad range of factors when 

considering new approaches to BSA/AML compliance such as performance, cost, and security of a particular technology. Any such 

processes should be transparent and reproducible so that banks 

and examiners understand how the system meets regulatory requirements. When developing innovative approaches, banks must 

continue to meet their BSA/AML compliance obligations. 

Q.7. Are the banking regulators working with FinCEN on future 

joint guidance? What would such guidance include? What impact 

would the guidance have under the new decision that guidance 

does not have the force of law? 

A.7. In December 2018, the Federal Reserve Board (Board) issued 

a joint statement with the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the National 

Credit Union Administration, and the Financial Crimes Enforcement Network that encourages depository institutions to explore 

innovative approaches to meet their BSA/AML compliance obligations and to further strengthen the financial system against illicit 

financial activity. 1 The statement recognizes that new technologies 

may help banks to more efficiently identify and report money laundering, terrorist financing, and other illicit financial activity. 

While the statement encourages banks to explore new ways of 

using their existing tools or adopting new technologies to meet 

their BSA/AML compliance obligations, the statement is not itself 

binding and expressly recognizes that some financial institutions 

may not have the means or ability to innovate. In addition, the 

statement makes clear that the Federal Reserve will not penalize 

banks that maintain effective anti– money laundering programs but 

choose not to pursue innovative approaches. 

Q.8. Merger and Acquisition Risk—In the Fed’s Supervisory Report 

released last week, you note that upcoming Regional Banking Organizations Supervisory Priorities include merger and acquisition 

risks. A number of banking experts said that reducing the capital 

requirements and other rules for banks above $50 billion would 

lead to more bank mergers. 

Do you expect to see more bank mergers this year and next year 

than the past few years? Can you estimate the number of bank 

mergers you expect in 2019? 
92 

2For supervisory purposes, the Federal Reserve generally defines regional banking organizations as those with total assets between $10 billion and $100 billion. 

A.8. When reviewing a bank holding company application or notice 

that requires approval, the Federal Reserve considers the financial 

and managerial resources of the applicant, the future prospects of 

both the applicant and the firm to be acquired, financial stability 

factors, the convenience and needs of the community to be served, 

the potential public benefits, the competitive effects of the proposal, 

the applicant’s compliance with laws and regulations, and the applicant’s ability to make available to the Federal Reserve information deemed necessary to ensure compliance with applicable law. 

Once a merger or application has been approved, we follow merger and acquisition (M&A) activity within the regional banking portfolio 2 chiefly to assess operational risk as the acquirers integrate 

the new operations into their consolidated organization. 

We continue to see significant M&A activity within the portfolio, 

and indeed the regional banking portfolio has grown as banking 

companies under $10 billion in assets accelerate their growth 

across that size threshold by performing acquisitions. 

We do expect M&A activity within the regional banking portfolio 

to continue, but any estimate of the projected level of this activity 

would be pure speculation, as it will depend on many different 

market factors. 

Q.9. How much of merger activity is due to changes from S. 2155 

and bank regulator actions to reduce some rules? 

A.9. The Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), enacted in May 2018, raised the asset 

threshold at which certain prudential standards apply from $50 billion to $100 billion. The new law also changed the asset threshold 

for a small bank holding company from $1 billion to $3 billion. Anecdotal evidence suggests that the former thresholds may have provided a merger disincentive to banks to grow beyond that point. At 

this time, the Federal Reserve does not have any specific evidence 

to indicate that merger activity has materially increased due to 

changes from EGRRCPA. 

Q.10. Since you note risks to regional banks arising from mergers 

and acquisitions, what are those risks? 

A.10. As noted in my response to 5(a), when reviewing a bank holding company application or notice that requires approval, the Federal Reserve considers the financial and managerial resources of 

the applicant, the future prospects of both the applicant and the 

firm to be acquired, financial stability factors, the convenience and 

needs of the community to be served, the potential public benefits, 

the competitive effects of the proposal, the applicant’s compliance 

with laws and regulations, and the applicant’s ability to make 

available to the Federal Reserve information deemed necessary to 

ensure compliance with applicable law. 

Once a merger or application has been approved, we follow M&A 

activity within the regional banking portfolio chiefly to assess operational risk as the acquirers integrate the new operations into their 

consolidated organization. Operational risks during integration can 

involve almost any aspect of running a bank, but the one that gives 
93 

the greatest supervisory concern is compatibility of information 

technology systems. The acquiring bank needs to ensure that the 

transition is smooth across all balance sheet and income statement 

accounts, that customers are not inconvenienced or exposed to errors as the accounts are integrated, and that management information systems (MIS) used for internal reporting—MIS that generates 

metrics on credit, liquidity, and market risks for example—accurately capture the new consolidated entity. 

Q.11. Liquidity Coverage Ratio/Stress Tests—Banks are required 

to retain enough assets they can easily convert to cash to cover 30 

days of expenses. You recommend reducing this cash cushion for all 

but the largest banks by revisions to the Liquidity Coverage Ratio. 

You say the reduction is minimal. Others say it is large and significant. Your Federal Reserve colleague, Governor Lael Brainard says 

it ‘‘weakens the buffers that are core to the resilience of our system.’’ 

How will you know if your analysis is wrong? How will you know 

if banks have less capital than prudent based on these regulatory 

changes you propose? 

A.11. The Board’s liquidity framework for large banking organizations has two general components: standardized measures, such as 

those included in the liquidity coverage ratio rule or net stable 

funding ratio proposed rule, and firm-specific measures, such as liquidity risk management requirements and internal liquidity 

stress testing requirements. 

The recent proposals to further tailor prudential standards would 

reduce or remove standardized liquidity requirements for some 

firms, but they would retain the firm-specific measures for all firms 

with $100 billion or more in total assets. As a result, the proposals 

would continue to require these firms to meet liquidity risk management standards, conduct internal liquidity stress tests, and hold 

a buffer of highly liquid assets sufficient to meet projected 30-day 

stressed cash flow needs under internal stress scenarios. The proposals would also require these firms to maintain regulatory reporting of key liquidity data, which facilitates the Board’s supervision of liquidity-related risks. In addition, the Board will continue 

to assess the safety and soundness of firms in the normal course 

of supervision. 

Taken together, these firm-specific standards and data reporting 

requirements will allow supervisors to continue to achieve regulatory objectives while improving upon the simplicity, transparency, and efficiency of the regime. In this manner, the proposals 

build on the Board’s existing practice of tailoring regulatory requirements based on the size, complexity, and overall risk profile 

of banking organizations. 

Q.12. If banks or their trade associations start taking the Federal 

Reserve to court due to their differences in how the tailoring 

worked, a stress test result or a cost-benefit analysis they do not 

agree with, will you feel your analysis was wrong? 

A.12. The Board takes seriously the importance in the rulemaking 

process of seeking comment from the public, carefully considering 

those comments, and assessing the costs and benefits of its rulemaking efforts. The Board believes strongly that public comment 
94 

and cost-benefit analysis can enlighten our regulatory actions and 

inform the implementation of our statutory responsibilities. In addition to seeking public comment on its proposals, the Board often 

collects impact information directly from parties that may be affected. Under the Board’s current practice, consideration of costs 

and benefits occurs at each stage of the regulatory or policymaking 

process. Recent examples of the publication of quantitative analyses in connection with its rulemakings include the global systemically important bank (G–SIB) surcharge rule, the singlecounterparty credit limit rule, and the long-term debt rule. 

The Board has established processes that allow institutions to respond to and appeal certain types of administrative actions, such 

as stress test results. In addition, the Administrative Procedure Act 

(APA) provides for judicial review of final regulations issued by the 

Board. Affected firms have the legal right to challenge the actions 

of any administrative agency under the APA, including whether 

the agency has engaged in reasoned decision making. Although the 

Board strives to robustly support all of its supervisory and regulatory actions, these appeal and judicial review processes help to 

ensure fair and effective implementation of our statutory responsibilities, consistent with applicable administrative requirements. 

Q.13. This isn’t just one weakening of buffers. There are numerous 

reductions at from several rulemakings that I think collectively 

have a material effect in weakening safeguards. Are you concerned 

that this ‘‘death by a thousand cuts’’ will result in much less of a 

capital cushion for banks that may find themselves in trouble in 

the future? 

A.13. Reforms implemented since the financial crisis have resulted 

in substantial gains in the resiliency of large banking organizations 

and the financial system as a whole. The proposals issued in October 2018 and April 2019, seek to tailor the Board’s prudential requirements for certain U.S. banking organizations and foreign 

banking organizations in accordance with the risk profiles of these 

firms while still maintaining the core reforms and gains made over 

the past decade. 

For liquidity standards, the proposals would continue to ensure 

that firms with the most significant risk profiles are subject to the 

most stringent liquidity requirements. For example, all U.S. G– 

SIBs and firms with very substantial size or cross-jurisdictional activity would be subject to the full liquidity coverage ratio and proposed net stable funding ratio requirements. The proposals would 

also require any firm with a high reliance on unstable short-term 

wholesale funding to meet the full requirements. This distinction 

would reflect these firms’ elevated vulnerability to liquidity risk, 

and help to reduce the risk of asset fire sales that could transmit 

distress to other market participants and destabilize the system. 

As noted in my response to question 6(a), all firms with assets greater than $100 billion will continue to be subject to firm-specific 

liquidity requirements. As a result, these firms will still be required to conduct internal stress tests and hold liquidity buffers 

sufficient to meet projected 30-day net stressed cash-flow needs. 

Further, with respect to capital, the proposals do not modify capital requirements of the largest, most systemically important bank-
95 

3 12 CFR part 208, subpart J, appendix D-1. 

ing organizations (U.S. G–SIBs and banks either that are very 

large or have substantial cross-jurisdictional activity). The proposals may result in an adjustment of capital requirements for 

smaller, less-systemic firms, although the impact on capital levels 

for these firms could vary under different economic and market 

conditions. The proposals also would also lower these firms’ compliance costs. As a result, the proposed requirements would reduce 

costs appropriately for those firms that have a limited impact on 

the financial system as a whole, relative to firms with more significant systemic footprints. 

Q.14. While you praise transparency in regulation, some warn that 

providing the textbook prior to the test or describing rigorous requirements for regulation allows banks to skirt the law in areas 

not yet covered. For example, there was probably little oversight of 

cryptocurrencies yet they have become a huge problem with Initial 

Coin Offering frauds. How will your focus on transparency avoid 

giving banks the option to make an argument that they not be tested or held accountable for something not clearly defined in the 

rules? 

A.14. Issuing clear regulations is fundamental to the legitimacy of 

democratically accountable institutions and is central to the Federal Reserve’s mission; regulated firms have a right to know the 

specific requirements that apply to them. While the Board is aware 

that prescriptive regulation may not capture all potentially harmful activity undertaken by regulated firms, the Board’s comprehensive supervisory regime is designed to identify such activity before 

it poses harm to a firm or to financial stability, and the Board also 

relies on its general safety and soundness authority 3 to address 

such activity. 

Q.15. Standard & Poor’s and Moody’s stated that weakening bank 

requirements is a credit negative for bank bond investors. An S&P 

report said ‘‘the Fed’s proposals are incrementally negative for 

bank creditors.’’ Moody’s report stated that the ‘‘reduced frequency 

of capital and liquidity stress testing could lead to more relaxed 

oversight and afford banks greater leeway in managing their capital and liquidity stress testing could lead to more relaxed oversight 

and afford banks greater leeway in managing their capital and liquidity, as well as reduce transparency and comparability, since 

fewer firms will participate in the public supervisory stress test.’’ 

Do you concur with two of the Credit Rating Agencies that your 

proposals—reducing or recalibrating capital requirements and 

stress tests—are ‘‘credit negative’’? Why or why not? 

A.15. The proposed adjustments to the Board’s capital and liquidity 

requirements are designed to efficiently tailor prudential standards 

to the risks of large banking organizations while ensuring that 

firms maintain sufficient resources and risk management practices 

to be resilient under a range of economic conditions. They are intended to maintain and support the postcrisis increases in resiliency. 

In regard to capital and liquidity requirements, including capital 

and liquidity stress testing requirements, the Board is focused on 
96 

reducing the complexity of the requirements in a way that does not 

materially lower the aggregate amount of total loss absorbing capacity maintained by banking organizations supervised by the 

Board. In addition, the Board is focused on tailoring the capital 

and liquidity prudential standards so that they are more reflective 

of the variety of business models and risk profiles observed across 

the industry, in a manner consistent with the requirements of 

EGRRCPA. 

Any adjustments to the Board’s regulatory requirements will be 

coupled with the Board’s continued commitment to strong supervision, and expectation that financial institutions manage their 

risks and maintain sufficient capital and liquidity to continue operations under stressed conditions. 

Q.16. Community Reinvestment Act and Regulatory Coordination— In your response to my questions for the record last Spring, you neglected to answer one of my questions. 

Which, if any recommendation from the Treasury Department or 

Comptroller Otting do you disagree with regarding the Community 

Reinvestment Act? 

A.16. Recommendations offered by the Treasury Department and 

Comptroller Otting on opportunities to modernize the Community 

Reinvestment Act (CRA) regulations have contributed to valuable 

analysis and dialogue among the agencies, as well as input from 

the public. As I have stated previously, I support the goal of improving the current supervisory and regulatory framework for CRA 

based on feedback from industry and community stakeholders. We 

are reviewing the information the OCC has received in response to 

its advanced notice of proposed rulemaking on the CRA, as well as 

information gathered through the Federal Reserve’s listening sessions at many of the Federal Reserve Banks around the country to 

determine whether there are steps we might take as regulators to 

come closer to both the letter and intent of the statute. That review 

is ongoing, and our evaluation of any particular proposal or element of a proposal will depend on a full analysis of the available 

information upon completion of that review. 

Q.17. As the Vice Chair of Supervision at the Fed, can you explain 

why there appears to be less interagency coordination, and more 

controversial proposals being advanced, since you took over the Supervisory role at the Fed? What is the potential for reducing public 

confidence and certainty in the regulatory actions you and others 

are attempting to take quickly and unilaterally? 

A.17. The Board consults and coordinates on a regular basis with 

its fellow bank regulatory agencies on a wide range of matters affecting depository institutions and their affiliates. This consultation 

and coordination facilitates a more cohesive regulatory framework, 

which is intended to promote the safety and soundness of the banking system in the most efficient and least burdensome way possible. The Board also consults regularly with the SEC, Consumer 

Financial Protection Bureau (CFPB), Commodity Futures Trading 

Commission (CFTC), OCC, FDIC, NCUA, and Treasury Department, in areas where regulatory responsibilities overlap. Coordination and cooperation with other agencies occurs at staff levels as 

well as through senior officers and members of the Board. In addi-
97 

tion, the Board participates in the Federal Financial Institutions 

Examination Council (FFIEC) and in the Financial Stability Oversight Council, both of which facilitate interagency consultation and 

cooperation. These many avenues of consultation at multiple levels 

increase the coordination and consistency of regulation across a 

banking industry that has multiple regulators and charters. 

Many of the proposals and final rules issued by the Board in recent months have been issued in coordination with other agencies. 

Recent examples of proposed or final rules issued in coordination 

with the OCC and FDIC include amending the definition of highquality liquid assets under the agencies’ liquidity rules; expanding 

eligibility for an extended examination cycle for insured banks and 

branches of foreign banks; raising the threshold for residential real 

estate transactions requiring an appraisal; and tailoring of liquidity 

and capital requirements for large banking organizations. Other recent examples of proposals issued in coordination with the FDIC 

and OCC include a proposal to establish a community bank leverage ratio, a proposal to streamline reporting requirements for small 

institutions, and a proposal to exclude community banks from the 

Volcker rule. The agencies continue to work together to implement 

other provisions of S. 2155 and on other matters of common interest. 

Q.18. Labor Market/Housing Market—The U.S. has seen consistent positive private sector job growth now for more than 100 

consecutive months. To what extent are these gains sustainable? 

What risks to the labor market do you see on the horizon? 

A.18. As you noted, private sector payrolls have increased every 

month since the spring of 2010. The labor market remains strong, 

and I expect the expansion to continue, with further positive job 

gains. 

As always, there are risks to the outlook, and admittedly, recessions are hard to foresee. But many studies demonstrate that economic expansions do not end simply because they have persisted 

for a long time. Rather, some shock or collection of shocks occurs 

that is sufficient to push the economy into recession. At present, 

the banking system is well capitalized and highly liquid, and the 

Federal Reserve is committed to do everything we can to sustain 

the ongoing expansion. The Federal Reserve’s recently inaugurated 

Financial Stability Report discussed risks and the resilience of our 

financial system in some detail. Other risks to the outlook could 

come from abroad, in the form of a material downturn to some of 

our trading partners or from the effects of Government policies, including trade policy and Brexit. 

While such downside risks are present, as reported recently in 

the Summary of Economic Projections, most Federal Reserve policymakers view the risks around our projections as balanced. Most 

importantly, policy is not on a preset course, and we will respond 

to changes in the economic outlook as warranted. 

Q.19. More than half of renters pay more than 1⁄3 of their income 

for rent. Nearly half of Americans cannot handle a $400 emergency. What are your concerns about the housing market where 

prices are high and supply—both rental and home ownership—is 
98 

inadequate in many communities? What should Federal policy 

makers do to increase the supply of affordable homes? 

A.19. A healthy labor market is one of the most important factors 

helping families afford their housing costs. Our labor market is 

currently quite strong overall. The unemployment rate is at its lowest level in many decades, and the strong job market has encouraged more people to seek and hold jobs. According to aggregate statistics, however, house prices and rents have been rising well above 

the growth rate of aggregate disposable household income. Moreover, aggregate statistics can mask important differences across regions of the country. This is especially the case with housing markets, which have distinct geographic and local features. While an 

improving labor market has produced some easing in the share of 

households that are cost-burdened, the share of cost-burdened 

households remains elevated relative to the period before the financial crisis, and I share your concern over what this means for the 

households affected. 

Housing costs have been rising because of increasing costs of 

labor and materials and, importantly, the availability and cost of 

land for residential construction, which are in turn influenced by 

local conditions and regulation. The Federal Reserve tracks conditions in the housing market and has noted the challenges of adding 

directly to the supply of affordable housing. Each of the regional 

Federal Reserve Banks has an active, well-staffed community development function—one of the great benefits of the Federal Reserve’s structure. We get important and timely information on the 

state of local economic and financial conditions, including those affecting low- and moderate-income, as well as other underserved, 

communities. Our community development staff at the Board and 

several Reserve Banks have conducted research to better understand housing affordability challenges, recognizing the importance 

of sufficient affordable housing to a community’s economic vitality. 

We also conduct and disseminate research on policy and practice 

solutions. Increasingly we have been exploring the challenges of 

supplying affordable rental housing and the role of local land use 

and zoning policies. 

Q.20. Banks Hoarding Interest Income as the Fed Raises Rates— 

Since the Fed began raising interest rates, banks have seen a significant jump in net interest income and charged consumers more 

for loans, all while keeping the interest rate paid on customer deposits relatively flat. Why are depositors not getting higher interest 

rates? 

A.20. Banks’ profits are partly determined by the difference in interest expense they must pay on deposits and other liabilities and 

the interest they earn on their assets, including loans. Interest 

rates on bank deposits are determined by private markets, as are 

the interest rates on loans, bonds, and other financial savings and 

investment products. A significant share of banks’ funding comes 

from customer deposits, for which banks must compete with other 

banks and nonbanks, such as money market mutual funds. Banks 

must also compete with other banks, nonbanks, and markets when 

setting lending rates for borrowers. Historically, we have seen that 

banks do not raise the rates they offer on customer deposits as 
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4See the Controlled Substances Act and 18 U.S.C. 1957. 

5https://www.fincen.gov/sites/default/files/shared/FIN-2014-G0011.pdf 

much or as quickly as interest rates on other bank products, such 

as loans, when the Federal Reserve raises its policy rate. Moreover, 

the rate paid by banks on their deposit accounts does not tend to 

rise as much or as quickly as the yields savers earn on alternative 

savings investments, such as money-market mutual funds. 

Of note, average advertised deposit rates are often an incomplete 

indicator of how banks attract and retain customer deposits. Presently, the range of rates offered by banks is wide, and many banks 

temporarily offer promotional rates. In addition, banks may use alternative methods to compete for deposits vis-a-vis other banks and 

money market mutual funds. Such alternative methods of compensating depositors include cash incentives, special rates that are not 

broadly advertised, and special offers on other services. We continue to study these trends and the ways in which changes in monetary policy transmit to the broader economy. 

Q.21. Cannabis Banking—As more States begin to legalize marijuana, it becomes imperative that Congress act on offering financial 

services for cannabis and cannabis affiliated businesses. In its first 

year of legalization, the State of Nevada collected $69.8 million in 

tax revenue from cannabis alone—this figure indicates that there 

is not an insignificant amount of cash that is floating around our 

financial system. 

Are you able to discuss whether, if any, how a lack of financial 

services for cannabis businesses impacts our monetary system? 

A.21. We understand that cannabis business may largely be conducted via cash transactions. Although the volume (and the attendant risk) of cash transactions may be large for any individual business, the scale of these businesses relative to the scale of the 

United States economy is quite small. As such, any additional cash 

activity from these businesses does not appear to be having any impact on the Federal Reserve’s ability to provide currency and coin 

nor on its ability to conduct monetary policy. 

Q.22. Could you discuss the regulatory burden that this prohibition 

places on federally chartered banks? 

A.22. Federal law makes it a Federal crime to possess, grow, or distribute marijuana, and prohibits an entity from knowingly engaging in a monetary transaction in criminally derived property. 4

Therefore, financial transactions that are related to marijuana are 

defined as money laundering under Federal law, even those related 

to operations that are licensed or approved under State law. The 

conflict between Federal and State law has created challenges for 

marijuana-related businesses and banks. 

In 2014, the Financial Crimes Enforcement Network (FinCEN) 

issued guidance to ‘‘clarify how financial institutions can provide 

services to marijuana-related businesses (MRBs) consistent with 

their Bank Secrecy Act (BSA) obligations.’’ 5 Similar to other BSA 

guidance, a reference to the 2014 FinCEN guidance was incorporated into the FFIEC BSA/AML Examination Manual. If there 

are legislative changes or if FinCEN repeals or revises its guid-
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ance, the Board, along with the other FFIEC agencies, will evaluate whether additional steps would be appropriate. 

Examiners assess whether the bank management has implemented controls that are commensurate with the bank’s risks, and 

when those risks involve MRBs as customers, examiners assess if 

the bank is complying with FinCEN’s 2014 marijuana guidance, including its suspicious activity report filing requirements. In general, examiners determine if the bank’s controls are commensurate 

with the risks posed by its products, services, and customers. As 

a general matter, the decision to open, close, or decline a particular 

account or relationship is made by a depository institution, without 

involvement by its supervisor.