U.S. GOVERNMENT PUBLISHING OFFICE

32–517 PDF WASHINGTON : 2018

S. HRG. 115–366 

FEDERAL RESERVE’S SECOND MONETARY POLICY 

REPORT FOR 2018 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED FIFTEENTH CONGRESS 

SECOND SESSION 

ON 

OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978 

JULY 17, 2018 

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

( 

Available at: http://www.fdsys.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 

KRISTINE JOHNSON, Professional Staff Member 

ELISHA TUKU, Democratic Chief Counsel 

LAURA SWANSON, Democratic Deputy Staff Director 

PHIL RUDD, Democratic Legislative Assistan 

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 

TUESDAY, JULY 17, 2018 

Page 

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

Prepared statement .......................................................................................... 37 

Opening statements, comments, or prepared statements of: 

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

Prepared statement .......................................................................................... 37 

WITNESS 

Jerome H. Powell, Chair, Board of Governors of the Federal Reserve System 4 

Prepared statement .......................................................................................... 39 

Responses to written questions of: 

Senator Brown ........................................................................................... 41 

Senator Corker .......................................................................................... 58 

Senator Cotton ........................................................................................... 59 

Senator Rounds ......................................................................................... 62 

Senator Scott ............................................................................................. 64 

Senator Tillis ............................................................................................. 66 

Senator Reed .............................................................................................. 69 

Senator Menendez ..................................................................................... 70 

Senator Warner ......................................................................................... 122 

Senator Cortez Masto ................................................................................ 125 

Senator Jones ............................................................................................ 141 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress dated July 13, 2018 ............................. 146 

Article submitted by Senator Brown ...................................................................... 212 

(1) 

FEDERAL RESERVE’S SECOND MONETARY 

POLICY REPORT FOR 2018 

TUESDAY, JULY 17, 2018 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:01 a.m., in room SH–216, Hart Senate 

Office Building, Hon. Mike Crapo, Chairman of the Committee, 

presiding. 

OPENING STATEMENT OF CHAIRMAN MIKE CRAPO 

Chairman CRAPO. This hearing will now come to order. 

Today we welcome Chairman Powell back to the Committee for 

the Federal Reserve’s Semiannual Monetary Policy Report to Congress. 

This hearing provides the Committee an opportunity to explore 

the current state of the U.S. economy and the Fed’s implementation of monetary policy and supervision and regulatory activities. 

Since our last Humphrey–Hawkins hearing in March, Congress 

passed, with significant bipartisan support, and the President 

signed into law S. 2155, the Economic Growth, Regulatory Relief, 

and Consumer Protection Act. 

The primary purpose of this bill is to make targeted changes to 

simplify and improve the regulatory regime for community banks, 

credit unions, midsize banks, and regional banks to promote economic growth. 

A key provision of the bill provides immediate relief from en- hanced prudential standards to banks with $100 billion in total assets or less. 

The bill also authorizes the Fed to provide immediate relief from 

unnecessary enhanced prudential standards to banks with between 

$100 billion and $250 billion in assets. It is my hope that the Fed 

promptly provides relief to those within these thresholds. 

By rightsizing regulation, the bill will improve access to capital 

for consumers and small businesses that help drive our economy. 

And the banking regulators are already considering this bill in 

some of their statements and rulemakings. 

Earlier this month, the Fed, FDIC, and OCC issued a joint statement outlining rules and reporting requirements immediately impacted by the bill, including a separate letter issued by the Fed 

that was particularly focused on those impacting smaller, less complex banks. But there is still much work to do on the bill’s implementation. 

2 

As the Fed and other agencies revisit past rules and develop new 

rules in conjunction with the bill, it is my expectation that such 

rules will be developed consistent with the purpose of the bill and 

the intent of the Members of Congress who voted for the bill. 

With respect to monetary policy, the Fed continues to monitor 

and respond to market developments and economic conditions. 

In recent comments at a European Central Bank Forum on Central Banking, Chairman Powell described the state of the U.S. 

economy, saying, ‘‘Today most Americans who want jobs can find 

them. High demand for workers should support wage growth and 

labor force participation . . . Looking ahead, the job market is likely to strengthen further. Real gross domestic product in the United 

States is now reported to have risen 2.75 percent over the past four 

quarters, well above most estimates of its long-run trend . . . 

Many forecasters expect the unemployment rate to fall into the 

mid-3s and to remain there for an extended period.’’ 

According to the FOMC’s June meeting minutes, the FOMC 

meeting participants agreed that the labor market has continued 

to strengthen and economic activity has been rising at a solid rate. 

Additionally, job gains have been strong and inflation has moved 

closer to the 2-percent target. 

The Fed also noted that the recently passed tax reform legislation has contributed to these favorable economic factors. I am encouraged by these recent economic developments and look forward 

to seeing our bill’s meaningful contribution to the prosperity of consumers and households. 

As economic conditions improve, the Fed faces critical decisions 

with respect to the level and trajectory of short-term interest rates 

and the size of its balance sheet. 

I look forward to hearing more from Chairman Powell about the 

Fed’s monetary policy outlook and the ongoing effort to review, improve, and tailor regulations consistent with the Economic Growth, 

Regulatory Relief, and Consumer Protection Act. 

Senator Brown. 

OPENING STATEMENT OF SENATOR SHERROD BROWN 

Senator BROWN. Thank you, Mr. Chairman. Welcome, Mr. Chair. 

It is nice to see you again. 

This week the President of the United States went overseas and 

sided with President of Russia while denigrating critical American 

institutions, including the press, the intelligence community, and 

the rule of law. 

Our colleague Senator McCain expressed clearly what every patriotic American thought: ‘‘No prior President has ever abased himself more abjectly before a tyrant. Not only did President Trump 

fail to speak the truth about an adversary; but speaking for America to the world, our President failed to defend all that makes us 

who we are—a republic of free people dedicated to the cause of liberty at home and abroad. American Presidents must be the champions of that cause if it is to succeed.’’ The words of the 2008 Republican Presidential nominee. 

With our democratic institutions under threat, we cannot ignore 

what happened in Helsinki yesterday. But we must not lose sight 

of the other special interest policies of this Administration, includVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
3 

ing the rollback of the rules put in place to prevent the next economic crisis. 

Just last week, a Federal Reserve official said, ‘‘There are definitely downside risks, but the strength of the economy is really 

pretty important at the moment. The fundamentals for the U.S. 

economy are very strong.’’ 

That may be true for Wall Street, but for most of America workers have not seen a real raise in years, young Americans are 

drowning in student loan debt, families are trying to buy their first 

home. For most of America, the strength of the economy is an open 

question. 

Last month former Fed Chair Ben Bernanke was very clear 

about the long-term impact of the tax cut and the recent bump in 

Federal spending when he said, ‘‘in 2020 Wile E. Coyote is going 

to go off the cliff.’’ 

Last week the San Francisco Fed released a study finding that 

the rosy forecasts of the tax bill are likely ‘‘overly optimistic.’’ It 

found that the bill’s boost to growth is likely to be well below projections—or even as small as zero. It suggested that these policies 

could make it difficult to respond to future economic downturns 

and manage growing Federal debt. 

And it is not just the tax bill. The economic recovery has not 

been evenly felt across the country. Not even close. Mr. Chairman, 

I would like to enter into the record an article from the New York 

Times this weekend which talks about those families still struggling from the lack of meaningful raises and other job opportunities. 

Chairman CRAPO. Without objection. 

Senator BROWN. Thank you, Mr. Chairman. 

While hours have increased a bit over the past year for workers 

as a whole, real hourly earnings have not. For production and nonsupervisory workers, hours are flat; pay has actually dropped 

slightly, according to the Bureau of Labor Statistics. 

The number of jobs created in 2017 was smaller than in each of 

the previous 4 years. Not what we hear in the mainstream media, 

perhaps. Some of the very companies that announced billions in 

buybacks and dividends are now announcing layoffs, shutting down 

factories, and offshoring more jobs. 

Some of the biggest buybacks, as we know in this Committee, are 

in the banking industry, assisted in part by the Federal Reserve’s 

increasingly lax approach to financial oversight. 

Earlier this month, as part of the annual stress tests, the Fed 

allowed the seven largest banks to redirect $96 billion to dividends 

and buybacks. This money might have been used, as the President 

and members of the majority party liked to promise during the tax 

bill, this money might have been used to pay workers, to reduce 

fees for consumers, to protect taxpayers from bailouts, or be deployed to help American businesses. 

Three banks—Goldman, Morgan Stanley, and State Street—all 

had capital below the amount required to pass the stress tests, but 

the Fed gave them passing grades anyway. 

The Fed wants to make the tests easier next year. Vice Chair 

Quarles has suggested he wants to give bankers more leeway to 

4 

comment on the tests before they are administered. I guess it is OK 

in Washington to let students help write the exam. 

The Fed is considering dropping the qualitative portion of the 

stress tests altogether—even though banks like Deutsche Bank and 

Santander and Citigroup and HSBC and RBS have failed on qualitative grounds before. 

That does not even include the changes the Fed is working on 

after Congress passed S. 2155 to weaken Dodd–Frank, making 

company-run stress tests for the largest banks ‘‘periodic’’ instead of 

annual and exempting more banks from stress tests altogether. 

And, oh, yeah, Vice Chair Quarles has also made it clear that 

massive foreign banks can expect goodies, too. 

And on and on and on it goes. The regulators loosen rules around 

big bank capital, dismantle the CFPB, ignore the role of the FSOC, 

undermine the Volcker Rule, and weaken the Community Reinvestment Act. 

When banks make record profits, we should be preparing the financial system for the next crisis. We should buildup capital, we 

should invest in workers, we should combat asset bubbles. 

And we should be turning our attention to bigger issues that do 

not get enough attention, like how the value that we place on work 

has declined in this country, how our economy increasingly measures success only in quarterly earning reports. 

Much of that is up to Congress to address. Over the last 6 

months, tragically, I have seen the Fed moving in the direction of 

making it easier for financial institutions to cut corners, and I have 

only become more worried about our preparedness for the next crisis. 

I look forward to the testimony, Mr. Chairman. And welcome, 

Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Brown. And, again, Chairman Powell, welcome. We appreciate you testifying today, and we 

look forward to your opening statement. You may proceed. 

STATEMENT OF JEROME H. POWELL, CHAIR, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. POWELL. Thank you and good morning. Good morning Chairman Crapo, Ranking Member Brown, and other Members of the 

Committee. I am happy to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress today. 

Let me start by saying that my colleagues and I strongly support 

the goals that Congress has set for monetary policy: maximum employment and price stability. We also support clear and open communication about the policies we undertake to achieve these goals. 

We owe you, and the public in general, clear explanations of what 

we are doing and why we are doing it. Monetary policy affects everyone and should be a mystery to no one. 

For the past 3 years, we have been gradually returning interest 

rates and the Fed’s securities holdings to more normal levels as the 

economy has strengthened. We believe that this is the best way we 

can help set conditions in which Americans who want a job can 

find one and in which inflation remains low and stable. 

I will review the current economic situation and outlook, and 

then I will turn to monetary policy. 

5 

Since I last testified here in February, the job market has continued to strengthen and inflation has moved up. In the most recent 

data, inflation was a little above 2 percent, the level that the Federal Open Market Committee thinks will best achieve our price stability and employment objectives over the longer term. The latest 

figure was boosted by a significant increase in gasoline and other 

energy prices. 

An average of 215,000 net new jobs per month were created each 

month in the first half of this year. That number is somewhat higher than the monthly average of 2017. It is also a good deal higher 

than the average number of people who enter the workforce each 

month on net. The unemployment rate edged down 0.1 percent over 

the first half of the year to 4.0 percent in June, near the lowest 

level of the past two decades. In addition, the share of the population that either has a job or has looked for one in the past 

month—what we call the ‘‘labor force participation rate’’—has not 

changed much since late 2013, and this development is another 

sign of labor market strength. Part of what has kept the participation rate stable is that more working-age people have started looking for a job, which has helped make up for the large number of 

baby boomers who are retiring and leaving the labor force. 

Another piece of good news is that the robust conditions in the 

labor market are being felt by many different groups. For example, 

the unemployment rates for African Americans and Hispanics have 

fallen sharply over the past few years and are now near their lowest levels since the Bureau of Labor Statistics began reporting 

these data in 1972. Groups with higher unemployment rates have 

tended to benefit the most as the job market has strengthened. But 

jobless rates for these groups are still higher than those for whites. 

And while three-fourths of whites responded in a recent Fed survey 

that they were doing at least OK financially, only two-thirds of African Americans and Hispanics responded that way. 

Incoming data show that, alongside the strong job market, the 

U.S. economy has grown at a solid pace so far this year. The value 

of goods and services produced in the economy—or GDP—rose at 

a moderate annual rate of 2 percent in the first quarter after adjusting for inflation. However, the latest data suggest that economic growth in the second quarter has been considerably stronger 

than in the first. The solid pace of growth so far this year is based 

on several factors. Robust job gains, rising after-tax income, and 

optimism among households have lifted consumer spending in recent months. Investment by businesses has continued to grow at a 

healthy rate. Good economic performance in other countries has 

supported U.S. exports and manufacturing. And while housing construction has not increased this year, it is up noticeably from 

where it stood a few years ago. 

Turning to inflation, after several years in which inflation ran 

below our 2-percent objective, the recent data are more encouraging. The price index for personal consumption expenditures, or 

PCE inflation—an overall measure of prices paid by consumers— 

increased 2.3 percent over the 12 months ending in May. That 

number is up from 1.5 percent a year ago. Overall or headline inflation increased partly because of higher oil prices, which caused 

a sharp rise in gasoline and other energy prices paid by consumers. 

6 

Because energy prices move up and down a great deal, we also look 

at core inflation. Core inflation excludes energy and food prices and 

generally is a better indicator of future overall inflation. Core inflation was 2.0 percent for the 12 months ending in May, compared 

to 1.5 percent a year ago. We will continue to keep a close eye on 

inflation with the goal of keeping it near 2 percent. 

Looking ahead, my colleagues on the FOMC and I expect that, 

with appropriate monetary policy, the job market will remain 

strong and inflation will stay near 2 percent over the next several 

years. This judgment reflects several factors. First, interest rates, 

and financial conditions more broadly, remain favorable to growth. 

Second, our financial system is much stronger than before the crisis and is in a good position to meet the credit needs of households 

and businesses. Third, Federal tax and spending policies likely will 

continue to support the expansion. And, fourth, the outlook for economic growth abroad remains solid despite greater uncertainties in 

several parts of the world. What I have just described is what we 

see as the most likely path for the economy. Of course, economic 

outcomes that we experience often turn out to be a good deal 

stronger or weaker than our best forecast. For example, it is difficult to predict the ultimate outcome of current discussions over 

trade policy as well as the size and timing of the economic effects 

of the recent changes in fiscal policy. Overall, we see the risk of the 

economy unexpectedly weakening as roughly balanced with the 

possibility of the economy growing faster than we currently anticipate. 

Over the first half of 2018, the FOMC has continued to gradually 

reduce monetary policy accommodation. In other words, we have 

continued to dial back the extra boost that was needed to help the 

economy recover from the financial crisis and the Great Recession. 

Specifically, we raised the target range for the Federal funds rate 

by a quarter percentage point at both our March and June meetings, bringing the target to its current range of 13⁄4 to 2 percent. 

In addition, last October we started gradually reducing the Fed’s 

holdings of Treasury and mortgage-backed securities, and that 

process has been running smoothly. Our policies reflect the strong 

performance of the economy and are intended to help make sure 

that this trend continues. The payment of interest on balances held 

by banks in their accounts at the Federal Reserve has played a key 

role in carrying out these policies, as the current Monetary Policy 

Report explains. Payment of interest on these balances is our principal tool for keeping the Federal funds rate in the FOMC’s target 

range. This tool has made it possible for us to gradually return interest rates to a more normal level without disrupting financial 

markets and the economy. 

As I mentioned, after many years of running below our longerrun objective of 2 percent, inflation has recently moved close to 

that level. Our challenge will be to keep it there. Many factors affect inflation—some temporary and others longer lasting. So inflation will at times be above 2 percent and at times below. We say 

that the 2-percent objective is ‘‘symmetric’’ because the FOMC 

would be concerned if inflation were running persistently above or 

below our 2-percent objective. 

7 

The unemployment rate is low and expected to fall further. 

Americans who want jobs have a good chance of finding them. 

Moreover, wages are growing a little faster than they did a few 

years ago. That said, they still are not rising as fast as in the years 

before the crisis. One explanation could be that productivity growth 

has been low in recent years. On a brighter note, moderate wage 

growth also tells us that the job market is not causing high inflation. 

With a strong job market, inflation close to our objective, and the 

risks to the outlook roughly balanced, the FOMC believes that—for 

now—the best way forward is to keep gradually raising the Federal 

funds rate. We are aware that, on the one hand, raising interest 

rates too slowly may lead to high inflation or financial market excesses. On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our 

objective. The Committee will continue to weigh a wide range of 

relevant information when deciding what monetary policy will be 

appropriate. As always, our actions will depend on the economic 

outlook, which may and will change as we receive new data. 

For guideposts on appropriate policy, the FOMC routinely looks 

at a range of monetary policy rules that recommend a level for the 

Federal funds rate based on the current rates of inflation and unemployment. The July Monetary Policy Report gives an update on 

monetary policy rules and their role in our policy discussions. I continue to find these rules helpful, although using them requires 

careful judgment. 

Thank you, and I will now be happy to take your questions. 

Chairman CRAPO. Thank you for your statement, Chairman Powell. 

The first question I have will relate to CCAR. As you know, the 

Fed recently released the results of the 2018 Comprehensive Capital Analysis and Review, the CCAR, stress test. This year the Fed 

issued conditional nonobjections to certain banks, which, as you are 

aware, some have criticized. What details can you share about the 

Fed’s decision to issue the conditional nonobjections while allowing 

those firms to maintain capital distributions at recent levels? 

Mr. POWELL. Thank you, Mr. Chairman. So the CCAR supervisory test is and will remain an important part of our supervisory 

framework, particularly for the largest and most systemically important firms. And I guess I would start by saying that this year’s 

test was by a good margin the most stringent test yet. Hypothetical 

losses for 2018 were $85 billion higher than during the 2017 stress 

test, and the hypothetical decline in the capital ratio was 110 basis 

points higher this year than last year; so a very significantly severe 

test, and it will result in a material increase in the effect of aggregate capital requirement of the firms subject to the test. 

So, you know, we carefully evaluated the results. We voted on 

them on June 20th, and the next day the firms received a call from 

our staff, which informed them of the results and their options. 

This is the standard operating procedure that we follow every year. 

There is no negotiation, there is no haggling. The decision has been 

made the day before by the Board, and they are just informed of 

their options, and they deal with them as they are. 

8 

Almost all the firms finished above the required poststress minimums, which is a sign of how well capitalized the industry is. Two 

firms that did not were required to restrict their distributions to 

past years’ levels. That has always been the penalty for failing to 

meet the poststress minimums, and that will require the firms to 

build capital this year, these two firms. The third firm was required to take certain steps regarding the management and analysis of its counterparty exposures under stress. So the same exact 

penalty was paid. We labeled these as conditional nonobjects rather 

than objecting straight out to the plan, and we have done that over 

a period of years many times, and we thought that it was appropriate here. 

When we fail a firm, when we actually fail them and send—what 

we do is we send the plan back and say that your capital planning 

process is deficient, please take this plan back, please fix it and 

bring it back to us, and we will look at it again. So that sends a 

signal that we believe that the capital planning processes of the 

firms are deficient in some serious way. 

As I mentioned, in a number of cases we have gone with sort of 

an intermediate sanction, and we felt that that was appropriate 

here. One reason for that is the timing of the tax bill, as we mentioned, and firms plan, of course, well in advance so that they will 

have enough capital to pass the test. This particular bill passed, 

was signed into law on December 22nd. We used fourth quarter 

capital levels for the test, so the TCJA resulted in a significant decrease in the level of capital these firms have. But, of course, they 

do not benefit from what in the longer term will be a lower tax effect on their earnings. So I think whereas any analyst would look 

at that law and say that it is positive for banks and for their ability 

to earn money, it was strictly a negative in this test. So we looked 

at that, and among other factors we decided to use the conditional 

nonobject. 

I will stop there, Mr. Chairman. 

Chairman CRAPO. All right. I appreciate that explanation, and 

essentially what I am hearing you say is that the same—in fact, 

even a stricter test was applied, and the same standards of review 

were used in your analysis and in the consequences that were applied. 

Mr. POWELL. That is right, and I just would reiterate our commitment to this particular supervisory stress test. It is a very important thing for us, and we will make sure to keep it stringent. 

Chairman CRAPO. All right. Thank you. 

Chairman Powell, moving to regulation, the recently enacted 

Economic Growth, Regulatory Relief, and Consumer Protection Act 

received significant bipartisan support, as you know. In addition to 

several provisions providing regulatory relief to community and 

midsize banks, a key provision of the bill raises the threshold for 

the application of the enhanced prudential standards from $50 billion to $250 billion. 

What is the Fed’s process for quickly implementing S. 2155, including its process for ensuring that the financial companies with 

total assets between $100 billion and $250 billion promptly receive 

similar relief to the relief provided for the financial institutions 

with less than $100 billion in total assets? 

9 

Mr. POWELL. So our intention and our practice is going to be to 

implement the bill as quickly as we possibly can. As you probably 

know, I am sure you know, we released a statement the Friday of 

July 4th week laying out our plans to move ahead with some 

things. And, again, we will do them as quickly as possible, and we 

indicated that we will try to move that along very quickly. 

Chairman CRAPO. All right. Thank you. 

Senator Brown. 

Senator BROWN. Thank you, Mr. Chairman. 

Mr. Chairman, I have a number of questions. I hope your answers can be brief. Thank you for our phone call the other day. I 

know you know this: In real terms wages have not budged recently. 

Last week BLS reported that hours for production and nonsupervisory workers are flat and pay has actually dropped over the 

past year. Of course, we should focus on real wages rather than 

nominal wages. By that measure, is the typical worker really better 

off this year than he or she was a year ago? 

Mr. POWELL. Yes. Yes, I would say that the labor market has 

strengthened. The labor report will show that wages went up 2.7 

percent. That is significantly higher than trend inflation. There is 

a bit of a bump from gas prices going up and consumers do pay 

that, but I would say that overall workers are better off because—— 

Senator BROWN. I would partially contradict that and say that 

nonsupervisory workers, four out of five workers have seen nominal 

wages go up but real wages have not by those same BLS statistics. 

Let me move to another. You have called stress testing ‘‘the most 

successful regulatory innovation of the postcrisis era’’—you said 

that some time ago—but the actions the Fed has taken during your 

tenure undercut that effect when the Fed gave Goldman, Morgan, 

and State Street passing grades this year even though they failed 

to meet capital requirements in CCAR, the first time that has ever 

happened in CCAR history. The Fed proposes to weaken the leverage constraint, and CCAR reportedly may drop the qualitative portion of the test, wants to give bankers more leeway to influence the 

Fed’s models, and may soon adjust Dodd–Frank stress tests to 

make them less stressful and less frequent, hence the ‘‘periodic.’’ 

Stress test tests were adopted in 2009 to provide confidence to 

the public that the banks could weather economic shocks. How is 

the public supposed to trust the stress test when the Fed proposes 

all of those ways to weaken them? 

Mr. POWELL. So we are strongly committed to using stress tests. 

We really developed the supervisory stress test at the Fed, and as 

you know, we think it is a very important tool. It was one of the 

main ways that we used to raise capital, particularly among the 

largest firms, and we are committed to continuing stress testing as 

one of the three or four most important innovations, along with 

higher capital, higher liquidity, and resolution. It is one of the big 

four pillars for us. 

The program has to continue to evolve. We want to strengthen 

it. We want to make it more transparent. We want to improve it 

over time. And all of our actions are designed to do that, and I 

think if you look at the state of the banking system and the fact 

that this test will require higher capital, then I think you will see 

10 

that is consistent with—that our words are consistent with our actions. 

Senator BROWN. Well, I think the message coming out emanating 

from the business press—and those are not, you know, Democratic, 

liberal newspapers; they are the Wall Street Journal, the Financial 

Times, the New York Times business section—speaks to the fact 

that these stress tests are getting weaker. 

Let me ask another question. Vice Chair Quarles has given two 

speeches outlining how the Fed wants to recalibrate the rules for 

large foreign banks. You gave an answer, a carefully worded answer, I thought, to obscure the fact that large foreign banks may 

receive less oversight as a result of S. 2155. The public is getting 

mixed messages from the Fed. 

For the record, can foreign banks with more than $50 billion in 

U.S. assets—Deutsche, Santander, Credit Suisse, the others—can 

foreign banks with more than $50 billion in U.S. assets expect to 

get regulatory relief during your tenure? 

Mr. POWELL. You know, I think I can say that S. 2155, it is not 

clear to me how it provides regulatory relief to those firms. I mean, 

all of the banks that have $50 billion in U.S. assets have more than 

$250 billion in global assets. So I do not think there really will be 

much effect. I will not say that we will never do anything to provide regulatory relief to a group during my tenure, but—— 

Senator BROWN. So your position seems to be that if they are between—if they are over 50 in the U.S., under 250 as those are, but 

much, much, much bigger with all the—— 

Mr. POWELL. Globally. 

Senator BROWN. Globally, that you do not expect any regulatory 

relief for them? 

Mr. POWELL. Well, the main thing is the $50 billion threshold for 

internal holding companies will remain the same. We are not looking at that. And I think they will not see much difference. 

Senator BROWN. Physical commodities. The Fed proposed a physical commodities rule for 2016. You are moving presumably to finalize it. The Fed responded to questions for the record saying that 

the Board continues to consider this proposal. When can we expect 

action on it, Mr. Chairman? 

Mr. POWELL. I do not have a date for you on that. I know that 

we received extensive comments on it, and we are considering 

them. 

Senator BROWN. Do you feel some urgency on it? 

Mr. POWELL. I will have to go back and look and see where that 

is in the line. 

Senator BROWN. If you would please respond in writing to that. 

And a last question, Mr. Chairman. The Administration and 

some in Congress pushed through tax cuts and bank deregulation 

under the guise that it would trickle down to American families in 

the form of more loans. Loan growth has slowed in the last quarter. 

It was less than half the growth rate than during the last year of 

the Obama administration. The four largest banks, as you know, 

redirected record levels of profits into dividends and stock 

buybacks. The four big banks’ CEOs got an average raise of 26 percent. 

11 

My question is simple: When, if ever, do you expect to be able 

to come before this Committee and demonstrate to us in this Committee, as Chair of the Fed, demonstrate to us how tax cuts and 

deregulation have actually benefited the real economy in the forms 

of more lending? 

Mr. POWELL. I guess I see my role as reporting about the overall 

economy rather than the effect of any particular law, although I 

will be happy to take questions on that. 

Senator BROWN. OK. Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Scott. 

Senator SCOTT. Thank you, Mr. Chairman. And good morning, 

Chairman Powell. Thank you for being with us today. 

Mr. POWELL. Good morning, Senator. 

Senator SCOTT. It certainly is difficult to find negative news as 

it relates to our economic reality. The truth of the matter is that 

we are in the third largest economic expansion since 1854—not 

1954—1854. An 18-year low in our unemployment rates. African 

American unemployment for the first time in recorded history 

below 6 percent at 5.9 percent. Hispanic unemployment at 4.6 percent, lowest recorded as well. Wage growth 2.7 percent, the highest 

level since 2009. And the Atlanta Federal Reserve suggests that we 

could have a 5-percent GDP growth in the second quarter. And the 

good news just keeps on coming. 

Small businesses said they have not been this optimistic in 45 

years. That has got to be a record. Beyond a doubt, tax reform combined with responsible regulations have resulted in more Americans have more money in their pockets. And another great example 

of the economic reality that we face today is that the core primeage labor force participation rate has stabilized since 2013 and is 

starting to climb in the right direction. 

My question for you, Chair Powell, is: What has been the overall 

impact of the economic growth for the long-term unemployed? And 

can we read into the prime-age labor force participation rate’s increase really positive news for those long-term unemployed? 

Mr. POWELL. Yes, so prime-age labor force participation, Senator, 

as you pointed out, has been climbing here in the last couple of 

years. That is a very healthy sign because prime-age labor force 

participation is really—you know, it has been weak, and it has 

been weak in the United States compared to other countries. So it 

is very troubling, and the fact that that is coming back up is a very 

positive thing. We really hope it is sustained, and we hope that 

these gains in participation can be sustained. We have a long box 

in our Monetary Policy Report that talks about that. 

The other thing, you mentioned the long-term unemployed. 

Senator SCOTT. Yes. 

Mr. POWELL. So the number of long-term unemployed has come 

down dramatically since, I do not know, maybe 2010. I want to say 

the numbers were between 6 and 7 million, and unless I get this 

wrong, I think the current number of longer-term unemployed is 

around 1.5 million. So the people who are on the very edges of the 

labor force like those people, those are the ones who have benefited 

the most. 

Senator SCOTT. Thank you. With all that economic heat coming 

our way in a positive way, the prices seem to be going up, so the 

12 

CPI rose 2.9 percent, the fastest pace since 2012. Those rising 

prices could negate some of the wage growth that I just talked 

about if left unchecked. 

In the past we have discussed, you and I, the Fed role according 

to the congressional mandate seeking stable prices being one of 

those specific mandates. We have also talked about the downsides 

of low interest rates for extended periods of time. What do you see 

in the prices for energy, housing, health care, and transportation? 

And how is that going to impact your thinking moving forward? 

Mr. POWELL. Inflation has been below our 2-percent objective 

since I joined the Board of Governors in May of 2012 just until last 

month. For the first time, we have 12 months of core inflation 

being at 2 percent. So that is a very positive thing. We want to see 

overall inflation continue to come up so that it is sort of symmetrically around 2 percent. I would say we are just shy of achieving 

that. But we want inflation to remain right around 2 percent and 

be as likely to be a little above as a little below. I would say we 

are on the—and I think our monetary policy is really designed to 

help us continue to achieve that. So we are gradually moving up 

rates, and that we think is the policy that will help us get inflation 

to 2 percent sustainably. 

Senator SCOTT. Thank you. Just two more areas for you. South 

Carolina, my home State’s economy is built on trade. You name it, 

we make it. We grow it and we ship it. Cars, cotton, tires, jets, 

peaches, soybeans, turbines, solar panels, and the list goes on and 

on. 

What has generally happened in the past to economic growth 

when we have raised tariffs? 

Mr. POWELL. I have to start by saying that, you know, I am really firmly committed to staying in our lane and, you know, our lane 

is the economy. Trade is really the business of Congress, and Congress has delegated some of that to the executive branch. But, 

nonetheless, it has significant effects on the economy, and I think 

when there are long-run effects, we should talk about it and talk 

in principle. And I would say in general countries that have remained open to trade, that have not erected barriers, including tariffs, have grown faster. They have had higher incomes, high productivity. And countries that have, you know, gone in a more protectionist direction have done worse. I think that is the empirical 

result. 

Senator SCOTT. I only have about 5 seconds left, so let me use 

my time wisely. As you know, I have a background in the insurance industry, and I am seriously a fan of a State-based system of 

insurance regulations. I think it is the best in the world. As the 

Fed participates in developing the ICS with the IAIS, I strongly 

urge you to shape a final product that protects the U.S. system of 

insurance regulation, and I would appreciate you and I having a 

conversation in the near future. 

Mr. POWELL. Thank you, Senator. 

Senator SCOTT. Thank you. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Reed. 

Senator REED. Thank you very much, Mr. Chairman. Welcome, 

Chairman Powell. 

13 

The issue of wages has been discussed by several of my colleagues and yourself. In 2000, the last time we were at this situation where we were touching 4 percent unemployment, the share 

of national income by corporations was about 8.3 percent, and the 

share of wages was 66 percent. Today we are once again reaching 

that point of about 4 percent unemployment, yet corporate profits 

account for about 13.2 percent of national income. They have gone 

up significantly. Wages as a share of national income have gone 

down from 66 percent to 62 percent. If those trends continue, we 

are in a situation where working men and women are not going to 

get their fair share of growth. What are you trying to do at the Fed 

to ensure that they get their fair share of growth? 

Mr. POWELL. The decline in labor share of profits—labor share 

of profits was generally, you know, oscillating fairly constant for a 

number of decades and right around the turn of the century began 

to drop precipitously and continued to do so for more than a decade. It is very troubling. We want an economy that works for everyone. And that happened, by the way, in essentially all advanced 

economies, and probably a range of factors are responsible for that. 

In the last 5 years or so, labor share of profits has been sideways. This is very much akin to the flattening out of median incomes over the last few decades. So it has got to do with a number 

of global factors. 

The thing that we can do is to take seriously your congressional 

order that we seek maximum employment, so in tight labor markets, workers are more likely going to be paid well and paid their 

share. I would say most of the factors that have driven down labor 

share of profits are really not under the control of the Fed. And so 

those are issues that we do not have control over. 

Senator REED. But would you say that the tax bill did not affect 

those downward trends in wages positively, that, in fact, it has 

done nothing to reverse what you have seen as a decade or more 

of decreases? 

Mr. POWELL. I think wages are set in the marketplace between 

workers and companies, and they are affected by a range of factors. 

I think it would be early to be looking for a bill that was signed 

into law less than a year ago to be able to visibly be affecting much 

of anything at this point, really. These things, big changes in fiscal 

policy, take quite a while to affect wages. 

Senator REED. So none of this good news we are talking about 

today is a result of this tax bill, it is too early? 

Mr. POWELL. It is very hard to isolate the—I mean, I would say 

wages have moved up meaningful over the last 5 years. It has been 

quite gradual. And, you know, we certainly think it would be fine 

for them to move up more. 

Senator REED. Do you think the European Union is a foe of the 

United States? 

Mr. POWELL. No, I do not. 

Senator REED. Thank you. 

As we look ahead to some of the potential obstacles—and having, 

both of us, lived through 2008 and 2009, it looked good and then 

it looked real bad. In retrospect, we saw some signs of the danger. 

What are the signs of danger that you are sort of focusing on? 

There are huge deficits, both Government deficits, private deficits 

14 

worldwide. You have got a trade battle brewing. And you have got 

things like Brexit that could complicate our life dramatically. So 

what are the two or three things that you think could throw us off 

this track? 

Mr. POWELL. There is a difference between the longer term and 

the short term. So in the near term, things look good. You know, 

we look very carefully at a range of financial conditions and financial stability vulnerabilities, we feel that those are at sort of normal, moderate levels right now, although there are some areas that 

are elevated, some assets prices are high, and there is an elevated 

level of debt in the nonfinancial corporate sector. More broadly, 

banks are well capitalized. Households are in much better shape. 

So financial stability I do not worry about too much at this point, 

although we keep our eye on that very carefully after our recent 

experience. 

You mentioned trade. It is hard to say what the outcome will be. 

Really, there is no precedent for this kind of broad trade discussions. In my adult life, I have not seen where essentially all of our 

major trading partners—hard to know how that comes out. If it results in lower tariffs for everyone, that would be a good thing for 

the economy. If it results in, you know, higher tariffs across a 

broad range of traded goods and services that remain that way for 

a longer period of time, that will be bad for our economy and for 

other economies, too. 

Senator REED. Thank you very much, Mr. Chairman. 

Chairman CRAPO. Thank you. 

Senator Rounds. 

Senator ROUNDS. Thank you, Mr. Chairman. 

Chairman Powell, first of all, I want to thank you for being here 

today. Before I get into the questions, I would just like to take note 

of the two rules that were announced this spring: the new stress 

capital buffer and the proposed changes to tailor the enhanced supplementary leverage ratio. I do appreciate the Federal Reserve’s efforts, and I hope we can continue an open dialogue on these 

changes as you move forward. 

I am just curious. You indicated with regard to Senator Reed’s 

question, based on the tax bill, clearly there is an improvement in 

GDP growth over the last couple of years. Was it anticipation of 

the tax bill being passed? I would like to flesh that out just a little 

bit, because most certainly I think a lot of truly believe that that 

tax bill is a key component in the development of an improvement 

in our GDP. Your thoughts? 

Mr. POWELL. I was really answering about whether you could see 

it in wages right now. That is hard to do. So growth averaged 

around 2 percent for 8 years, and then in 2017, I think the current 

estimate is 2.6 percent. And you saw significant improvements in 

household and business confidence levels. Overall confidence about 

the economy, you saw that coming on in 2017. Some of that was 

probably in anticipation of the passage of what finally passed. So 

probably that was already in the growth rate. I think it is hard to 

say, but I suspect that some anticipation of tax cuts and tax reform 

was already in the growth in 2017. 

Going forward—and we have said this—we expect—there are a 

range of estimates on this, but we would expect that the tax bill 

15 

and the spending bill would provide meaningful support to demand 

for at least the next 2 or 3 years, maybe 3 years, and also might 

have, you know, effects on the supply side as well. To the extent 

you are encouraging more investment, you are going to get higher 

productivity. So it is very—these estimates are subject to tremendous uncertainty both as to amount and as to timing. But I think 

we look at the range of estimates, and that is certainly where we 

broadly come out. 

Senator ROUNDS. I just want to be clear. That tax bill had a positive impact, even if it is the anticipation of the tax bill. It has a 

positive impact on our GDP growth, correct? 

Mr. POWELL. Yes, I think, so this year, maybe last year, too. 

Senator ROUNDS. OK. Let me ask you this: With regard to trade, 

you make notes specifically in your comments on trade and the fact 

that there are some things up in the air right now. There is perhaps some instability or some questions on the part of not only our 

businesses but businesses around the world. Are businesses looking 

for stability with regard to trade compacts? Or are they looking for 

opportunity and instability? 

Mr. POWELL. Well, they would clearly be looking for stability. 

Senator ROUNDS. OK. And then I would look to associate myself—and I support what Senator Scott indicated earlier with regard to the insurance issues and the fact that our State-based regulatory system for insurance I think is critical. I think it is a positive thing for consumers when it is as close to that State regulatory 

process as possible. 

When you came here before the Committee earlier this year, you 

discussed capital requirements in the options market and mentioned that the Federal Reserve was working on a rule to transition 

from the risk-insensitive Current Exposure Method, or CEM, to the 

internationally agreed upon Standardized Approach for 

Counterparty Credit Risk, SA–CCR. I am supportive of these efforts, but I remain concerned about the timeline for implementation. I noted with concern in a letter to Vice Chair Quarles last 

year, in response to my request that the Federal Reserve used its 

reservation of authority to grant interim relief, Vice Chair Quarles 

asserted that the Fed lacks such authority in this context. I originally raised this issue when Vice Chair Quarles was testifying at 

his confirmation hearing last July. Unfortunately, it has been a 

year since that time, and the Fed has yet to take meaningful action. 

I remain concerned about this because the longer we wait for 

American regulators to implement SA–CCR, the more market makers will exit the options market entirely, making our financial system more vulnerable to economic shocks and less competitive compared to our international peers. 

I noted in the Basel Committee’s last progress report from April 

of 2018 that 22 of the 27 Basel member countries have either implemented SA–CCR or made substantially more progress at implementation compared to the United States. I am a particularly 

strong supporter of risk-based capital standards, particularly in 

this context in options markets. Can you provide an update on 

when the rulemaking from CEM to SA–CCR will be released? 

16 

Mr. POWELL. I know that we are working on it now. I know that 

we think it is good policy. And I cannot give you an exact date, but 

I know we are actively directing a rule. By not being able to provide interim relief, all we meant was we actually have to amend 

the rule. So we will be putting a rule out for proposal and get comments, and then it will go final. It is in train, but these things take 

time. We are working on it. 

Senator ROUNDS. OK. Thank you. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Menendez. 

Senator MENENDEZ. Thank you. Thank you, Chairman Powell, 

for being here. 

Lately we have heard a near constant refrain from the Administration, the President himself, corporate media outlets, and even 

from you that ‘‘the economy is doing very well’’ and ‘‘it has never 

been better.’’ 

Now, if we take a narrow view of the unemployment rate and 

corporate profits, then, sure, it is a real rosy picture. But take a 

wider lens to what working families are seeing, and the view is one 

of great contrast. 

Over the last year, despite falling unemployment, working families actually saw their real wages fall. By comparison, after-tax corporate profits increased by 8.7 percent just in the last quarter. 

There is something fundamentally wrong in our economy when 

workers are seeing their pay cut while corporations are benefiting 

from a $2 trillion tax giveaway. Working families not only cannot 

get ahead, but they are actually falling behind. 

I can tell you, families in New Jersey cannot keep up with the 

surge in costs, particularly for prescription drugs and health care. 

I just heard from a constituent in Glendora, New Jersey, who told 

me that even with his Medicare and secondary insurance, he cannot afford to pay for his insulin and diabetes equipment, and that 

is pretty unconscionable. 

So my question to you, Mr. Chairman, is: When will the benefits 

of this ‘‘booming economy’’ reach working families? 

Mr. POWELL. Thank you, Senator. I think we are aware and I am 

aware that while the aggregate numbers are good and unemployment is low and surveys overall of households are very positive 

about the job market, not everybody is experiencing the recovery. 

Not every demographic group, not every place are experiencing 

this. So we call that out in every FOMC meeting and in all of our 

public communications, as I did in my testimony this morning. 

And, you know, we understand that we have to take maximum employment seriously, and we do. We have been supporting a strong 

labor market for a long time. Despite many calls for us to raise interest rates much more quickly, I am glad that we stayed in longer 

than that, and I think gradually raising rates is the way for us to 

extend this expansion. Nothing hurts working families and people 

at the margin of the labor markets more than a recession. 

Senator MENENDEZ. Well, you are probably going to have a couple more interest rates. What specific steps then are you taking to 

foster broad-based wage growth so that the average worker, not 

just managers and executives, are reaping the benefits? I cannot 

accept that wages are growing when the Bureau of Labor Statistics 

17 

points out that production and nonsupervisory workers saw their 

wages fall two-tenths of a percent, and that is despite increasing 

their average work week to make up for it. So they are getting 

squeezed. 

Mr. POWELL. So the latest Government report was that wages 

went up 2.7 percent for production, nonsupervisory workers, and 

supervisory workers over the last 12 months. And that is higher. 

That is moving up. It also happens that inflation has moved up and 

that sort of a bump in energy prices is passing through the headline inflation number. So I think overall, though, you see inflation 

at about a 2-percent trend. You see wages at 2.7 percent. So I think 

those trends are healthy, and I think they are reflected in what are 

pretty positive surveys among workers generally. 

Senator MENENDEZ. Let me ask you this: These working families 

we are talking about are the first to feel the impact when banks, 

big banks, and corporations take risky bets with no accountability. 

When we passed Dodd–Frank, we included language to ban incentive-based compensation practices that reward senior executives for 

irresponsible risk taking. Regulators issued a proposal in 2016, but 

more than 2 years later, nothing has been finalized. In the meantime, Wall Street bonuses jumped 17 percent last year to an average of more than $184,000—the most since 2006, and that is bonuses alone. 

Now, you have made time to weaken Wall Street oversight by revisiting capital rules, revisiting leverage rules, proposing changes 

to the Volcker Rule, all of which were finalized after years of deliberation, public comments, and input from other regulators, and all 

of which protect our economy from another financial crisis. How is 

it, Mr. Chairman, that you have not made time to finish the incentive-based compensation rulemaking for the first time? And can 

you give me a commitment today as to a timeline for when this will 

be done? 

Mr. POWELL. We tried for many years—it is a multiagency rule, 

the incentive comp rule. We tried—we were not able to achieve consensus over a period of many years between the various regulatory 

agencies that need to sign off on that. But that did not stop us from 

acting, you should know. Particularly for the large institutions, we 

do expect that they will have in place compensation plans that do 

not provide incentives for excessive risk taking. And we expect that 

the Board of Directors will make sure that that is the case. And 

so it is not something that we have not done. We have, in fact, 

moved ahead through supervisory practice to make sure that these 

things are better than they were, and they are substantially better 

than they were. You see much better compensation practices here 

focusing mainly on the big firms where the problem really was. 

Senator MENENDEZ. Well, that does not have the power of a rule. 

I hope we can get to a rule-based purpose, because at the end of 

the day we seem to have revisited everything that was already 

completed, but yet we cannot get this one going. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. And, Mr. Chairman, 

thank you for being here. I was remarking to our staff yesterday, 

as we talked a little bit about this meeting, that because of the way 

18 

that you are handling yourself, which I think is in a very positive 

way, following the Fed is getting really boring these days. But 

hopefully that will continue. I know that is your goal. We appreciate some of the transparency efforts that you have put forth. 

I think I heard you earlier talk about inflation, and obviously we 

are, you know, at full employment. Hopefully there will be additional people participating in the workforce that have not in the 

past, and I am glad to see those numbers are rising. But if I understand correctly what you are saying, the predictive stat for people 

who are watching the Fed today will be core inflation. In other 

words, that will be the determinative factor as it relates to rate increases in the future. 

Mr. POWELL. So we, of course, look at headline inflation, too, and 

that is our legal mandate. We look at core inflation when we are 

thinking about the path of future inflation, though, because it is 

just a better predictor. Many of the things that affect headline inflation do not actually send much of a signal about future inflation. 

Senator CORKER. But for people who are trying to see where 

things are going, now that the labor issue is where it is today, the 

predictive matter as it relates to future increases and the amount 

of those is really going to be inflation. 

Mr. POWELL. Inflation is going to be really important. You know, 

I think we are—for quite a while here, we have been in the range 

of achieving our maximum employment goal, and we are only just 

getting there with inflation. I would not declare victory on that yet, 

either. 

Senator CORKER. Yeah, it has really been difficult, I think, for 

many Western countries to get to a place that they are comfortable 

in inflation, which brings me to the wage issue. 

Look, like my colleagues, I am very concerned about wage stagnation, and I am not in any way trying to offload that issue to you. 

We all have responsibilities to put in place policies that will hopefully cause all Americans’ wages to increase. But what we are seeing here and what we are seeing actually, let us face it, in Western 

countries around the world is people are not—the anticipation that 

people had relative to where they were going to be in life is not 

being achieved, which is creating some extremes as it relates to the 

political environment—actually, in some ways beginning to destabilize, because people are, rightly so, concerned about the fact that 

they are not really increasing the ability to raise their families as 

they wish. 

Let us talk a little bit about that. What is it from your perspective that is causing us to be in this place where the economy is 

growing, but for the last 30 years, Americans really have not seen 

the wage gains that they would like to see? Could you just lay 

out—not in any way to take responsibility at the Fed solely yourself, but what is driving that? 

Mr. POWELL. You know, the stagnation of middle-class incomes, 

the relatively low mobility that we have, the disappointing level of 

wages over a long period of time, it is all of a piece, and it all does 

go to that. And I think the causes of these things are really deep. 

It is not something we can address really successfully over time 

with monetary policy, as you say. So, I mean, I think it is—— 

Senator CORKER. What are those deep causes? 

19 

Mr. POWELL. So I think, you know, part of it is, in our case, in 

the case of the United States, stagnation of educational achievement, the leveling out of educational attainment. When U.S. educational attainment was rising, technology was coming in; it was 

asking for more skills on the part of people. They had those skills, 

and so you had productivity rising, you had incomes rising, you had 

inequality declining over a long period of time. 

U.S. educational attainment flattened out in the 1970s, and everywhere else in the world it has been going up. We really had a 

lead. We were the first country to have gender-blind, you know, 

secondary education universally. So that is a big thing. Really the 

only way for incomes to go up over a long period of time is through 

higher productivity. Real incomes go up over a long period of time 

because of higher productivity. Higher productivity is a function of, 

in part, the educational and skills and aptitude of the workforce. 

It is also, you know, partly the evolution of technology and investment. 

I think right now in particular we had a number of years of very 

weak investment after the crisis because there was no need to invest. That weak investment period is casting a shadow over productivity right now, which is one of the main factors that is holding 

down wages. These are deep, hard problems, but education is really 

at the bottom of the pile. 

Senator CORKER. And I am glad you alluded to that, and my time 

is up, I know. But we have had—we actually have had productivity 

growth without wage growth. 

Mr. POWELL. Over long periods of time, the only way wages can 

go up sustainably is with productivity growth. They do not necessarily match all the time. I mean, since the crisis ended, productivity growth has been—output per hour has been very, very weak. 

Increases have been very, very weak. 

Senator CORKER. Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Tester. 

Senator TESTER. Thank you, Chairman Crapo and Ranking Member Brown. And thank you for being here, Chairman Powell. I want 

to run over some stuff that has been run over already just real 

quick. 

You had answered in a previous question that the stress tests 

continue. Is that correct? Stress tests continue on the banks? 

Mr. POWELL. Absolutely. Every year. 

Senator TESTER. And you said you were going to try to improve 

them, make them more transparent, which, by the way, I applaud 

that. Would you also add to that list that you are trying to weaken 

the stress tests? 

Mr. POWELL. No, absolutely not. 

Senator TESTER. You are still making them do what they need 

to do to prove that their soundness is there? 

Mr. POWELL. The 2018 stress test was by a margin the most 

stringent stress test we have done yet. 

Senator TESTER. OK. Folks also continue to be concerned that S. 

2155 allowed foreign megabanks like Deutsche Bank, UBS, 

Barclays to see their enhanced prudential standards weakened. 

You have agreed—and you have said it again today—that S. 2155 

20 

does not do that. Do you have any plans to weaken standards on 

the largest FBOs that I mentioned? 

Mr. POWELL. No. No, sir. 

Senator TESTER. OK. In your testimony you said, ‘‘Good economic 

performance in other countries has supported U.S. exports and 

manufacturing.’’ What other countries are you talking about? 

Would that include the EU? Would that include Canada and Mexico, the other countries, I am talking about, that have good economic performance? Would that include China? Those other countries—— 

Mr. POWELL. It would include all those countries, yes. 

Senator TESTER. All those countries? And I know you said that 

the tariff situation and the trade situation is something that Congress deals with that you do not deal with, but it would appear to 

me—and I just want to get your opinion on this because I value 

it. It would appear to me that all this stuff about getting out of 

NAFTA and putting tariffs on folks and not being at the table 

when TPP was finally signed is a net negative on our economy. 

Would you agree with that long term—short term and long term? 

Mr. POWELL. I am going to try to walk that line that I mentioned 

earlier and not comment on any particular policy, but in principle, 

open trading is good. We do not want countries to have barriers to 

trade or, you know, tariffs being a barrier to trade. 

Senator TESTER. Both directions. 

Mr. POWELL. In both directions. We want to have an international, you know, rules-based system in which countries can get 

together and any country that violates that can face the other 

countries, and that system has served us very well. Tariffs have 

come down steadily over the years. Until recently, they were at 

their all-time low level. But the thing is we do not know how this 

goes. This process we are in right now, the Administration says it 

is going for broadly lower tariffs. If that happens, that is good for 

the economy. That would be very good for the economy—our economy and others’ too, by the way. On the other hand, if we wind up 

with higher tariffs, then not so good. 

Senator TESTER. That is correct. And in the meantime, just as a 

sidebar, if it cuts off foreign markets for grains, for example, there 

is going to be a lot of people in family farm agriculture that are 

put out of business. And that is my concern. You do not need to 

comment on that. 

I realize that you do not play a central role in our housing finance system, but you do play a central role in our economy, and 

the Fed does have a sizable balance sheet with billions of dollars’ 

worth of mortgage-backed securities on the books. 

In March it was announced that Fannie Mae and Freddie—no, 

not Freddie, but Fannie Mae would need $4 billion from its line of 

credit at the Treasury Department. How concerning is this to you 

and the Fed given the size of mortgage-backed securities that are 

on your books? 

Mr. POWELL. The mortgage-backed securities that we have are 

guaranteed by the Federal Government. There is no credit risk 

there. I would say more generally, if this is responsive, I think that 

the housing finance system, the GSEs, remains one of the big unfinished pieces of business postfinancial crisis, and I think it would 

21 

be healthy for the economy and for the housing finance system to 

see that move forward. 

Senator TESTER. You answered my second question. So you think 

that Congress’ inability to address Fannie Mae and Freddie Mac in 

the end could harm our economy? 

Mr. POWELL. I think it is really important for the longer run that 

we get the housing finance system off the Federal Government’s 

balance sheet and using market forces and some of the things that 

are already in place and carry forward some kind of a reform. I 

think it is very important for the economy longer term. 

Senator TESTER. OK. Thank you, Chairman Powell, and I appreciate your being here. I have got a couple other questions for the 

record that I would love to have you answer. 

Thank you very much. 

Mr. POWELL. Thanks. 

Chairman CRAPO. Senator Toomey. 

Senator TOOMEY. Thanks, Mr. Chairman. Thank you, Chairman 

Powell, for joining us. 

I just had a quick follow-up on this wage discussion. I think the 

most recent numbers we had were the month of June. Comparison 

to the previous June, 2.7 percent I think was the nominal growth 

in the wage number, so obviously a positive number. I think we 

would all like to see a bigger real growth. I think there is no question we would like to see that. But I would suggest that there is 

something peculiar about just the arithmetic of this sometimes, and 

maybe you could just briefly comment on this. 

As our economic growth has coincided with a significant growth 

in entry-level jobs and people coming into the workforce at entrylevel wages, since those wages are at the low end of the wage spectrum, isn’t it the case that the nature of arithmetic is that the average wage will reflect to some degree the fact that new entrants 

naturally come in at the low end of the spectrum and it would 

mask the growth in wages of people who have been continuously 

employed? 

Mr. POWELL. Yes, that is right. There can be compositional effects, is what we call them, so younger people coming in, lower 

wages; older people, higher wages, retirement can be an effect. I 

am not sure it is right now, but I can check on that. 

Senator TOOMEY. I think that is likely to be the case as we have 

increasing workforce participation. I think that is a likely consequence. 

You made a very important point, I think, earlier that sustained 

wage growth absolutely requires sustained productivity growth. It 

is not possible to have the former without the latter. We all know 

that productivity growth is driven by several things, but one of the 

principal contributing factors is capital expenditure. It is new tools 

and equipment and technology in the hands of workers that make 

them more productive. 

The June FOMC minutes included a disturbing observation, and 

I will quote very briefly. It says, ‘‘Some districts indicated that 

plans for capital spending had been scaled back or postponed as a 

result of uncertainty over trade policy.’’ So the FOMC is saying 

that there is already adverse consequence in the form of scaled 

back investment as a result of uncertainty in trade policy. If there 

22 

is more uncertainty—and we have threats of additional tariffs 

hanging over the markets right now—doesn’t it follow that this is 

a threat to wage growth because the continuum includes a reduction in capital expenditure, lower productivity growth than we 

would otherwise have in a corresponding relative weakness in wage 

growth? 

So, in other words, isn’t all this trade uncertainty a threat to 

wage growth? 

Mr. POWELL. It may well be. We do not see it in the numbers 

yet, but we have heard a rising chorus of concern which now begins 

to speak of actual cap ex plans being put on ice for the time being. 

Senator TOOMEY. Yeah, which is really disturbing. The Senator 

from Tennessee’s question about what causes stagnant wages, well, 

it corresponded to an extended period of very low productivity 

growth, which itself corresponded to very low capital expenditure 

growth. We broke that with the incentives in the tax reform that 

caused a big surge in cap ex. And it would be a tremendous pity 

to jeopardize that because of the trade policy. 

Let me move on to a somewhat technical matter regarding the 

Fed’s balance sheet. As you know, historically the Fed has manipulated just overnight rates, the discount rate and Fed funds rate, 

and let the markets decided all other interest rates. That all 

changed with quantitative easing when the Fed became the biggest 

market participant in the purchase of Treasurys. And it changed 

in an explicit way when the Fed decided that it would intentionally 

manipulate the shape of the yield curve with Operation Twist, 

which was very consciously and willfully designed to change the 

shape of the curve. 

My understanding is now, to the extent that you make purchases 

of Treasurys, which you do when payments come back to the Fed 

in excess of what you want to run off, you do so basically as a set 

proportion of what the Treasury is issuing without regard to where 

on the curve they are issuing. 

So while this is happening, the yield curve is flattening and in 

a pretty dramatic way, right? Twos, tens were like a hundred basis 

points a year ago. Today they are, I do not know, 25 basis points. 

Some people are concerned that a flattening curve or an inverted 

curve correlates with economic slowdown and recession. 

Here is my question: Does a dramatic change in the shape of the 

yield curve in any way influence the trajectory that you guys are 

on with respect to normalizing interest rates and the balance 

sheet? 

Mr. POWELL. Sorry. In other words, are we going to change our 

balance sheet policies due to the—is that what you are asking—due 

to the changing shape of the curve? 

Senator TOOMEY. Yeah, does the changing shape of the curve 

weigh into your considerations at all? 

Mr. POWELL. You know, I think what really matters is what the 

neutral rate of interest is, and I think population look at the shape 

of the curve because they think that there is a message in longerrun rates, which reflects many things, but that longer-run rates 

also tell us something, along with other things, about what the 

longer-run neutral rate is. That is really, I think, why the slope of 

the yield curve matters. So I look directly at that rather than—in 

23 

other words, if you raise short-term rates higher than long-term 

rates, you know, then maybe your policy is tighter than you think, 

or it is tight, anyway. 

So I think the shape of the curve is something we have talked 

about quite a lot. Different people think about it different ways. 

Some people think about it more than others. I think about it as 

really the question being what is that message from the longer-run 

rate about neutral rates. 

Senator TOOMEY. Yeah, I think that makes a lot of sense. 

I see my time has expired. Thank you, Mr. Chairman. 

Chairman CRAPO. Let me check. 

Senator WARNER. I got in under—— 

Chairman CRAPO. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. Chairman Powell, 

it is great to see you again. Part of the challenge coming this late 

in the hearing is a lot of my questions have been answered. I want 

to follow up a comment at least on what Senator Toomey was addressing. I was going to cite the minutes of the Fed June meeting 

as well in terms of you say you have not seen these effects in the 

economy yet, but there has been a slowing of cap ex because of concerns about what I think is the President’s kind of ill-thoughtthrough trade war. I strongly believe we ought to take into consideration and have a fair and balanced trading system. I think China 

is the worst offender, particularly in the theft of intellectual property and other items. I was actually applauding the President when 

he moved strongly at first for a day or two on ZTE and before he 

folded at the first pushback from President Xi. And I would argue 

that we would be in a stronger position vis-a-vis citizenship if we 

had been about to actually rally other nations around the world, 

nations that are our allies. Instead, he is engaged in trade practices with them. No need to comment on that. 

Senator Tester raised an issue I wanted to raise as well, indicating foreign banks that have relatively small U.S. subsidiaries 

but large overall international assets are still going to be subject 

to stress tests. As a matter of fact, wasn’t it correct that at least, 

since there are a variety of stress tests, the CCAR stress tests still 

applies to institutions that have assets at any level or relatively 

any level, and that there was recently a foreign bank with $900 billion of total assets but only $86 billion in U.S. assets that the 

CCAR stress test still applied to? Is that not correct? 

Mr. POWELL. I believe that is correct. 

Senator WARNER. OK. I think you have addressed that, and 

there are some tensions here between—the Chairman is a good 

friend of mine and all. I think there may be appropriate regulatory 

relief for some regional banks, but I want to make sure—and I 

think you have addressed this with Senator Tester—that for those 

banks in that 100 to 250 range, you can have a thorough process 

and rulemaking process that stress tests are going to continue on 

a regular basis, and that these banks that fall into this category 

are going to be strictly reviewed before they might receive some of 

this regulatory relief to make sure that they—you know, size alone 

may not be the only indicator of significance to the overall market, 

and there may be some institutions that fall in that category but 

still need the enhanced SIFI diagnosis. 

24 

Mr. POWELL. Right, so the bill gives us all the authority we need, 

frankly, to reach below 250 down to 100 and apply any prudential 

standard we want, either on the grounds of financial stability or 

just the safety and soundness of banking companies. We will published—we are thinking about it carefully now. We are going to 

publish for public comment the range of factors that we can consider. And, again, the bill is very generous in letting us consider 

all the factors that we think are relevant. 

Senator WARNER. But one of the reasons that I was supportive 

of the legislation was testimony that you had given prior to the 

passage that this was not going to be some blanket dismissal of 

these institutions, that you were going to go through a thorough 

rulemaking process and make an evaluation before those regulations were relaxed. Is that still your position? 

Mr. POWELL. We will, absolutely. In fact, there is one institution 

now that is designated as a SIFI that is less than 250. So we are 

not shy about finding financial stability risk when we find it. 

Senator WARNER. We think, again, the lines are always arbitrary 

here, but it is up to you and the Fed to make sure that institutions, 

particularly based upon their business practices that may be overall economically significant, that they still will have that determination, as you indicated, even if they fall below 250. 

Mr. POWELL. Yes, a wide range of factors it will be. 

Senator WARNER. Let me move to a different topic. I recently 

sent you a letter with a number of my Democratic colleagues on the 

Community Reinvestment Act, and I think the renewal of that act 

is very important. And I am concerned that the OCC has proposed 

a policy that will ‘‘only consider lowering component performance 

test ratings of a bank if evidence of discrimination or illegal credit 

practices directly relates to the institution’s CRA lending activities.’’ 

The way I read that would mean that under the OCC’s proposal, 

which I think is inappropriate, you could end up with a bank still 

getting a good CRA rating, even though they had discriminatory 

practices, but simply those discriminatory practices fell outside of 

its CRA lending processes. So my hope would be for those banks 

that fall under the Fed’s review that we will not see a relaxing of 

those CRA standards. 

Mr. POWELL. You have correctly stated what our policy is, and 

I have every reason to think that it will continue to be that. We 

am not looking to change it. 

Senator WARNER. I would hope so, and I want to make sure we 

will follow up with additional letters and requests on that subject. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you. 

Senator Van Hollen. 

Senator VAN HOLLEN. Thank you, Mr. Chairman. Mr. Chairman, 

welcome. Good to have you here. 

A couple questions that relate to the tax bill, because much has 

been said about that. Senator Toomey mentioned that it has resulted in increased investment. What I have seen is a huge whopping increase in stock buybacks. In fact, as of today, the number 

is $600 billion in stock buybacks. Those are corporations that have 

decided not to invest the money back into their workers or their 

25 

plant or their equipment, but give it to stockholders, which included, I should say, one-third of the stock holdings in this country 

are foreign stockholders. So it is a great windfall for the accounts 

of foreign stockholders. 

Much has also been claimed about the economic impact. I am 

looking at the most recent projection that the Fed had for median 

long-term growth. As of your June 13th report, I see it is 1.8 percent, is that correct, for the current long-term growth median projection? 

Mr. POWELL. Yes, it is. 

Senator VAN HOLLEN. Are you aware of what the projection was 

a year ago before the tax bill was passed? 

Mr. POWELL. I am going to say 1.8 percent. 

Senator VAN HOLLEN. It was 1.8 percent. I mean, the reality is, 

despite all the hype around here, it is not really going to have an 

impact on our long-term growth. Surprisingly, a lot of us did think 

there was going to be a sugar high. When you dump $2 trillion into 

the economy, you would think there would be some sugar high, and 

maybe there will be some sugar high. But I was interested in an 

analysis that came out of the San Francisco Fed. I do not know if 

you saw it. Two economists there actually said that the 2017 tax 

law is likely to give maybe not even a sugar high. Have you had 

a chance to review that analysis? 

Mr. POWELL. I have, and I would just say that, you know, there 

is a wide range of estimates of the effects of the recent fiscal 

changes, and, you know, they are talking about the possibility—I 

think their point was late in the cycle when you are near full employment, the effects might be less. You know, they might or they 

might not be. I think there is a lot of uncertainty. 

One of the great things about the Fed is we get a range of views, 

which is a healthy thing. 

Senator VAN HOLLEN. But it does stand to reason, right, that you 

would have a smaller impact late in a cycle? I mean, that is why 

most fiscal policy in this country over the years has said that we 

want to provide stimulus during the really tough times when a lot 

of people are out of work, but you do not necessarily want to provide stimulus sugar high when the economy is clicking on all cylinders. And I think that is the point these economists made, is we 

are actually in the ninth year of growth. 

So when you are talking about some increase in real wages, not 

nearly what we want—I mean, that is over the 9-year period. Is 

that right? 

Mr. POWELL. I am sorry. Your question? 

Senator VAN HOLLEN. When you talk about some small uptick in 

real wages, that is over the period of recovery, right? 

Mr. POWELL. I was really talking about nominal wages, and what 

I was talking about was if you look at 2012, 2013, 2014, all of our 

main wage things sort of were around 2 percent, measures around 

2 percent. Now they are close to 3 percent. So it was not an overnight thing, overnight sensation. It was a gradual increase. But 

you have seen a meaningful increase. 

Senator VAN HOLLEN. Right. And isn’t a fact that real wage increases were higher during the last term of the Obama administration than during the Trump administration? 

26 

Mr. POWELL. I would really have to go back and look at that. 

Senator VAN HOLLEN. I have the advantage, Mr. Chairman, of 

having your detailed Fed analysis and the Bureau of Labor Statistics. And what it shows is that, in fact, real wage increases were 

higher during the last term of the Obama administration. The 

point here really is not play make-believe, as we sometimes hear 

around here, that this tax bill somehow miraculously helped a lot 

of people out. The reality is, as we heard, real wages are pretty 

flat. I understood your testimony about oil price increases. We do 

not know how long they will be with us. But we also know that real 

wage increases were higher during the 4 years of the Obama administration than so far in the Trump administration with the tax 

cut and everything else. 

So I hope that my colleagues will bring more of a discussion 

based—a reality-based discussion to this. The one thing we do 

know that tax bill did, the one thing we did know is it is going to 

add about $2 trillion to our national debt, a debt that will have to 

be paid off by everybody in this room and their kids and grandkids. 

And at the same time, the Fed projection shows no change in the 

long-term growth projections. So we just blew $2 trillion. A lot of 

it is already going to stock buybacks, and I just hope we will sort 

of end the happy talk about what this tax cut did. 

Thank you. 

Chairman CRAPO. Senator Heitkamp. 

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

Chairman Powell, for once again coming before the Committee and 

being willing to answer our questions. 

I want to just make a point about wages, and you do not need 

to comment on this. Almost 20 percent of the people in our country 

who are wage earners earn less than $12.50 an hour. I do not know 

how many of you think you can live on $12.50 an hour, but I 

think—given that you are working a 40-hour week. Thirty-two percent earn between $12.50 and $20 an hour. Twenty dollars an hour 

is just barely $40,000 a year. And the next 30 percent is $22 to 

$30, much of it heavily weighted on the light end. In fact, I have 

seen one survey that has told us that two-thirds of all wage earners in this country earn less than $20 an hour, hourly wage earners. 

If you do not think that that presents economic challenges if that 

does not change, we are wrong. I think that there is optimism. Optimism is leading to taking on more consumer debt. I think we are 

seeing that. The response, and I think appropriate, that you have 

on interest rates is going to drive increased costs. We have targeted 

or linked the student loan rate to what you do, thereby exacerbating those people who are attempting to take that next leap forward. So I just want to make the point that where your job is to 

look at macro, we visit with people every day in our States who are 

struggling, struggling to make ends meet. 

And I want to transition to the next place for me on North Dakota struggles, and that is trade. You know, I have been asking 

questions about trade for 2 years now. So if you look at the minutes of the Fed meeting, which I think Senator Toomey talked 

about, businesses across the country from steel and aluminum to 

farming have been telling Fed officials about plans to pull back 

27 

their investments in their business or offshore their business. We 

have now pork producers talking about moving their pork production offshore to basically avoid what has been happening in the 

pork industry. 

These industries I think have good reason to be concerned. 

Economists across the spectrum, including economists in the private sector, Morgan Stanley and Goldman Sachs, European Central 

Bank, the IMF, they are all raising alarms with trade tensions 

looming. 

So if the President’s trade policies continue to result in escalating 

tariffs by our trading partners, I think this is going to have serious 

damage to the economy and, in particular, to producers and consumers in my State. 

Now, just to give you a number, North Dakota is the ninth most 

dependent on imported steel. That surprises people, but you think 

about our base industry. What is one of the primary inputs in drilling and in moving oil? It is steel. What is one of the primary inputs 

in large equipment manufacturing? It is steel. And I have heard 

from my equipment manufacturers that what amount they got in 

tax savings has been gobbled up in the first 2 or 3 months of this 

fiscal year. 

Then we are not even talking about farmers with the double 

whammy of getting hit with steel tariffs—they are large steel 

users—and seeing their commodity prices being challenged. 

You offered a view last week that the President’s trade war results in other countries actually lowering their trade barriers. Then 

that would be a positive outcome. I do not disagree. However, the 

historic and economic evidence suggests the opposite is likely to 

occur. In fact, if you look at efforts such as Smoot–Hawley—we can 

go all the way back there—we know and I believe history will tell 

you that it contributed significantly to the depth of the Great Depression. I do not say it causes it, but it certainly did not assist 

in early recovery. 

So would you agree with former Chairman Ben Bernanke when 

he said in a 2007 speech on trade that restricting trade by imposing tariffs, quotas, or other barriers is exactly the wrong thing to 

do for the economy? 

Mr. POWELL. I would, assuming you are talking about them remaining in place over a sustained period of time. Absolutely. 

Senator HEITKAMP. Well, you know, I get a little frustrated by 

this short-term pain for long-term gain. I think that we are going 

to have long-term consequences in agriculture because I think we 

are going to have emerging markets in the competitive space that 

we have not before. We already see the Chinese are subsidizing 

their farmers to grow soybeans. We see that Brazil and Argentina 

are amping up their soybeans and, arguably, could be, in fact, buying American soybeans, marking them up and enjoying our market 

with the markup as we struggle. 

So in that same speech, then-Chair Bernanke cites studies which 

show that the effects of protectionist policies almost invariably lead 

to lower productivity in U.S. firms and lower living standards for 

U.S. consumers. Is there any reason to believe that these studies 

are no longer valid? 

Mr. POWELL. None that I know of. 

28 

Senator HEITKAMP. OK. Chair Powell, I make the point on 

Bernanke’s comments and historic record because we cannot afford 

to put our head in the sand and ignore the facts about the impact 

of the Administration’s trade policies on our economy. I think it is 

clear—I have been probably one of the most outspoken critics of the 

President’s trade policy here, certainly on this side of the aisle. And 

if we want to improve trade, the right way to do it is to expand 

trade agreements, in my opinion, not impose reciprocal tariffs. 

And so I am deeply concerned—and I know that at this point you 

are taking a watchful eye. But I am deeply concerned about the 

long-term ramifications of this so-called short-term policy. And certainly if we see the next tranche, the $200 billion, and then beyond 

that we see tariffs on automobiles, we will, in fact, be in a full-on, 

escalated, damaging trade war. And I do not know where that 

ends. And if this is a game of who blinks first, the best thing to 

do would be to get to the negotiating table. 

Now—oh, I am over my time. 

Chairman CRAPO. Yes. 

Senator HEITKAMP. I am sorry. But I want to make the point 

that I am going to stay on this. I am going to stay on the macro 

effects of this trade policy, because this is not good for our economy, and we are going to look back at this time perhaps in a year 

and say that is the point at which we turned the corner and the 

economy started taking a downturn. 

Chairman CRAPO. Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. And good to see you 

again, Chairman Powell. 

Before the financial crisis, banks loaded up on risky loans while 

regulators just looked the other way. And when those loans went 

bad, taxpayers were left holding the bag because big banks did not 

have enough capital to stay afloat. 

Dodd–Frank included two major reforms to make sure that this 

never happens again: first, rules that make big banks meet higher 

capital standards so they are better equipped to handle losses; and, 

second, rules that make the banks take annual stress tests to ensure that they are not taking on too much risk. 

But since you have taken over, Chairman Powell, the Fed has 

rolled back on both of these reforms, and I just want to explore 

what that means for our economy. 

In April the Fed proposed an amendment that lowers the enhanced supplementary leverage ratio. That is the special capital requirement for the too-big-to-fail banks. The FDIC claims that this 

reform will allow the banks to maintain $121 billion less in capital, 

but the Fed disagrees with the FDIC’s assessment. Why is that? 

Mr. POWELL. We actually think that the effect of that proposed 

change which is under consideration—we are looking at the comments—would be pretty close to zero as it relates to the firm itself. 

And, also, we think—in other words, if you look at the entire entity, it would be less than $1 billion. I will not say zero, but I think 

our estimate was $400 million. 

Senator WARREN. So you just think the FDIC’s $121 billion estimate is made up? 

29 

Mr. POWELL. They are talking about the bank; whereas, we are 

talking about the whole firm. Within the whole firm, at the firm 

level—— 

Senator WARREN. But the banks we have to worry about are the 

banks that get bailed out here. 

Mr. POWELL. Yeah, and the enhanced supplemental leverage 

ratio, the problem with this is that we do not want a leverage ratio 

to be the binding capital requirement because it actually calls 

upon—if you are bound by that, you are actually called upon to 

take more risk. So we would rather not have the bank bound by 

that. 

Senator WARREN. So let us take a look at this in terms of trying 

to strengthen the banks so that we do not have to be in a position 

to bail them out. The second thing you have done is you have put 

a lot of stock in stress tests, and last week you called the stress 

tests ‘‘the most successful postcrisis innovation for bank regulation.’’ But under your leadership, the Fed has weakened the stress 

test regime. 

Here is one example. Results of this year’s exercise recently became public and reportedly three banks—Goldman Sachs, State 

Street, and Morgan Stanley—had capital levels that were too low 

to pass the test. I wrote to you about these banks a few weeks ago, 

and I appreciate your response on this. But just to be clear, after 

they flunked, did you give those too-big-to-fail banks a failing 

grade? 

Mr. POWELL. We gave them what we call a ‘‘conditional nonobject,’’ which is something we have done—— 

Senator WARREN. OK, but that is not a failing grade, right? They 

did not flunk. 

Mr. POWELL. They suffered the same penalty, which was to have 

to limit their distributions to the prior years. 

Senator WARREN. Well, that is what I want to ask. If you did not 

flunk them, did you at least follow the Fed guidelines and make 

those banks submit new capital plans that would pass the test? 

Mr. POWELL. No. In fact, when we do the conditional nonobject, 

we do not require them to resubmit—— 

Senator WARREN. So you do not require them to actually meet 

the criteria. 

Mr. POWELL. In the many times we have used that tool over the 

years, we have not required that. 

Senator WARREN. In other words, the Fed looked the other way. 

You let these banks off with what you call a conditional nonobjection, letting them distribute capital to their shareholders instead of 

keeping it on their books. In fact, because of your action, Morgan 

Stanley and Goldman Sachs investors took home about $5 billion 

more than they otherwise would have. That is nice gift to the bank, 

Mr. Chairman. 

On top of that, the Fed also proposed a rule in April that would 

make the stress tests less severe, effectively reducing capital requirements at the eight largest banks by a total of about $54 billion, according to a Goldman Sachs analysis. 

So, Chairman Powell, by your own account, the economy is doing 

well. We all know that bank profits are gigantic. The banks just 

got huge tax breaks. Three Fed Presidents—President Rosengren, 

30 

President Mester, and President Evans—have suggested it is an 

ideal time to raise capital requirements to strengthen the banks instead of siphoning off cash to shareholders. So why is the Fed 

under your leadership persistently seeking to reduce capital requirements and weaken stress tests? 

Mr. POWELL. With respect, Senator, we are not doing either of 

those things. In fact, the stress test in 2018 was materially more 

stressful—the amount of the loss and the amount of required capital to pass the test was the highest by far of any test. 

Senator WARREN. Look, I do not know what to say. The FDIC 

does not see it that way. Goldman Sachs does not see it that way. 

The data do not seem to back you up on this. The Fed’s capital requirements and the stress test are like a belt and suspenders. You 

can loosen the belt and rely on the suspenders, or you can take off 

the suspenders and rely on the belt. But if you do both, your pants 

will fall down. And, Chairman Powell, we learned in 2008 that 

when the big banks’ pants fall down, it is the American economy, 

American taxpayers, American workers who get stuck pulling them 

back up. So it looks like to me the Fed is headed in the wrong direction here. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Senator Schatz. 

Senator SCHATZ. Thank you, Mr. Chairman. Chairman Powell, 

thank you for your service, and thank you for being willing to engage. I understand the need for you to stay in your lane, so I am 

going to ask a question, and I want to have as constructive of an 

exchange as possible, knowing that some of this ground has been 

covered, and I do not want to turn this into a partisan conversation. 

Banks are doing well. They had record-breaking profits in the 

years 2016 and 2017, and it looks like 2018 is going to be another 

gangbuster year. Across the board, banks increased their dividends 

by 17 percent in 2017, 12 percent in 2018. Community banks’ earnings are also up. Household credit is up. 

In April, after your speech to the Economic Club of Chicago, you 

said, and I quote, ‘‘As you look around the world, U.S. banks are 

competing very, very successfully. They are very profitable. They 

are earning good returns on capital. Their stock prices are doing 

well. So I am looking for the case for some kind of evidence that 

regulation is holding them back, and I am not really seeing that 

case as made at this point.’’ 

The data backs up your statement. Banks are the most profitable 

that they have ever been. So what is the motivation for weakening 

Dodd–Frank rules like the Volcker Rule? 

Mr. POWELL. I think we want regulation to be as efficient as well 

as effective as it can possibly be. Regulation is not free. Regulation, 

good regulation, has very positive benefits—avoiding financial crises, avoiding consumer harm, and things like that. But nobody benefits when regulation is inefficient. And so we have taken the job, 

particularly for the smaller institutions going back and looking at 

everything we have done over the last decade, to make sure that 

we are doing it in the most efficient way possible. That is what we 

are doing. We want the strongest, toughest regulation to apply to 

the biggest banks, particularly the eight SIFIs. And then we want 

31 

to make sure that we have tailored appropriately as we move down 

into regionals and subregionals and then large community banks 

and then smaller ones. 

Senator SCHATZ. OK. A fair answer. What would you say to 

someone back home who says, ‘‘Why would the Fed focus on this? 

Why would the Banking Committee focus on this? Why would the 

Federal legislative branch focus on making life easier for the banks 

given income inequality, given that these are literally the most 

profitable institutions in American history?’’ I get that it is always 

better to make things more efficient. It just seems like you have 

limited resources and we have limited political capital to spend on 

priorities for the Fed. What do I say to someone back home who 

says, ‘‘Why are you taking care of these guys who seem to be feeding at the trough pretty nicely?’’ 

Mr. POWELL. I think you have to distinguish between different 

kinds of institutions. You know, I do not think that the smaller 

community banks are maybe feeling quite as healthy as you are 

saying. I think they are healthy. But I think, you know, we want 

them to be devoting their efforts to making loans and investing in 

their communities, supporting economic activities in communities, 

not—— 

Senator SCHATZ. But lending is up, right? And profitability is at 

least somewhat of a proxy for the efficiency of the regulations. I 

will not belabor this. I take your answer in good faith. 

In a recent interview with Marketplace, you were asked what 

keeps you up at night. This is one of the things I enjoy about you, 

is you are frank in your responses while trying to stay in your lane. 

And you said, ‘‘We face some real longer-term challenges, again, associate with how fast the economy can grow and also how much the 

benefits of that growth can be spread through the population. I 

look at things like mobility. If you judge the United States against 

other similar well-off countries, we have relatively low mobility. So 

if you are born in the lower end of the income spectrum, your 

chances of making it to the top or even to the middle are actually 

lower than they are in other countries.’’ 

Understanding that the Fed cannot address these issue squarely, 

can you talk a little bit about income inequality and what ought 

to be done? And then my final question around income inequality 

is whether, to the extent that you have expressed this view, a tax 

cut that provides about $33,000 for individuals in the top 1 percent 

of earners and about 40 bucks to the poorest of the poor, whether 

or not that helps or hurts in terms of income inequality. 

Mr. POWELL. There are a range of—the question I was answering 

in that interview and that you are really asking is really these are 

issues that the Fed does not have the tools or the mandate to fix, 

but they, nonetheless, involve significant longer-term economic 

challenges. So I just would—you know, I pointed out low mobility, 

which is the research of Raj Chetty, who is a professor back at 

Harvard now, and also just the stagnation of median incomes for 

a long time. And if you look at things like labor force participation 

among prime-age males, you have seen a decline over 60 years. 

These are unhealthy trends in the U.S. economy that we do not 

have the tools to fix. You do. These are things for the legislature 

to work on. And, you know, it comes down to things that are easy 

32 

to say and hard to do, like improve education, deal with the opioid 

crisis, things like that. And I also think, you know, balanced regulation plays a role in this and in enabling capital to be allocated 

freely and people to move from job to job. All those things go into 

it. But these are long-run important issues, particularly—another 

one is the potential growth rate of the country, which looks like it 

has slowed down because of aging, really, and demographics and 

things like that. 

So these are big issues. We cannot really affect them with monetary policy. 

Senator SCHATZ. Thank you. 

Chairman CRAPO. Senator Cortez Masto. 

Senator CORTEZ MASTO. Thank you. Chairman Powell, thank you 

for being here, and thank you for also answering our questions. I 

appreciated your comments earlier in the introduction, and noting 

what you admitted that the aggregate numbers do look good. 

But I also noted in your presentation that there is a quote that 

you say, and it is this: ‘‘And while three-fourths of whites responded in a recent Federal Reserve survey that they were doing 

at least OK financially’’ in 2017—‘‘at least OK, only two-thirds of 

African Americans and Hispanics responded that way’’ when it 

comes to financially whether they were doing OK. And I think that 

is what this comes down to. It comes down to those individuals who 

are living out there who are struggling, how much money is in 

their pocket, how much it can pay for. 

I notice you talked about the wages are up 0.27 percent, price 

index increased 2.3 percent. So in response to Senator Menendez’s 

question about the steps that you were taking for broad-based 

wage growth, you answered several things. But let me ask you this: 

Is it your opinion that it is the Fed’s responsibility or role to do 

something about wage growth, broad-based wage growth to play a 

role there? 

Mr. POWELL. I think, you know, what you have assigned us is literally maximum employment and stable prices, and also financial 

stability, we have an overall responsibility for that. Maximum employment, the sense of that is it is not just one measure. It is a 

broad range of measures, and I think we have really—you know, 

we have worked hard to provide support for the labor markets. 

Senator CORTEZ MASTO. And that would include wage growth 

then? 

Mr. POWELL. It would. Wage growth comes into really both of 

those things. It comes into maximum employment. It also comes 

into inflation. 

Senator CORTEZ MASTO. Good. I am glad you said that because 

here is the other thing that you said that concerned me, and you 

said one way to address and increase wage growth was incomes 

need to go up, and they only go up with higher productivity. And 

that is what you said needs to occur. 

But let me ask you this, because I have looked at some of the 

economists and studied some of the reports in the last 30 years or 

so, and I know that was true probably from 1950 to the 1970s, that 

they were both going up together. But we also have studies that 

show from 1973 to 2016 it was just the opposite. They are divergent, that productivity went up by 73.7 percent, but the hourly pay 

33 

went up 12.5 percent, only 12.5 percent. That is 5.9 times more, 

more productivity than pay. 

So knowing that, how can you say that we need to focus on higher productivity because that will also increase wages? 

Mr. POWELL. So what I said was that over a long period of time, 

wages cannot go up sustainably without productivity also increasing. It is a different thing to say that higher productivity guarantees higher wages. I did not say that, and I do not think that is 

true. I know very well the charts you are talking about. 

Senator CORTEZ MASTO. So then what tools—then what are you 

doing to address wage growth to ensure that we are increasing 

wages? Because here is what is happening—and you know this. If 

you are in your community—and I am hoping you are—and you are 

talking to people across America, you know that wages have been 

flat since 1973. That means that the people when I go home—and 

me and my family and Nevadans in general who are struggling, 

they do not have enough money to pay for housing costs, for health 

care, for education, for prescription drugs. And what do I tell them 

that you are doing to look out for their interests to help them and 

improve their lives with the tools that you have? 

Mr. POWELL. The tool that we have is monetary policy, and we 

can and we have—— 

Senator CORTEZ MASTO. No, I appreciate that. Let me ask you 

this: Can you just put it in terms if you are talking to a constituent 

in my State to explain to them what you are doing—now, remember, Nevada was a place where we had the foreclosure crisis. People lost their homes, and they lost their jobs. We had 15 percent 

unemployment at one point in time, underwater in their homes. 

What would you say to those individuals that you are doing to ensure, one, it does not happen again and, two, improve the wage 

growth for them? 

Mr. POWELL. We are doing everything we can with our tools to 

make sure that if you want a job, you can have one, and we are 

also—— 

Senator CORTEZ MASTO. But having a job and having a livable 

wage are two different things. 

Mr. POWELL. Over the long term, we do not have those tools. You 

have those tools. Congress has the tools to assure stronger wage 

growth over time. We really do not have that with—we can move 

interest rates around to support activities, support hiring. We do 

not have the tools to support higher productivity, for example, 

which tends to lead to higher wages without guaranteeing them. 

Senator CORTEZ MASTO. As an economist, you can work with us 

and tell us the tools or the things that can be done, like increasing 

the minimum wage, that might improve livable wages for individuals, correct? 

Mr. POWELL. I would say principally over long periods of time investing in education and in skills are the single—that is the single 

best thing we can do to have a productive workforce and share 

prosperity widely, which is what we all want. 

Senator CORTEZ MASTO. And I know my time is up, and I appreciate that. But I am concerned. Is that based on your own individual opinion, or is that research or data or information that you 

know that shows that? 

34 

Mr. POWELL. It is a lot of research. 

Senator Cortez Masto. OK. Thank you. 

Chairman CRAPO. Senator Donnelly. 

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

Mr. Chairman. 

Mr. Powell, I am worried about farmers in my State. I checked about an hour ago. Soybean prices are $8.40 a bushel, well below 

the cost of production right now. Corn is $3.48 a bushel, well below 

the cost of production. In the last couple of weeks, I have visited 

with a number of Hoosier farmers and groups like the Indiana 

Corn and Soybean Alliance and the Indiana Farm Bureau to hear 

their growing concerns with falling commodity prices and uncertain 

trade policies, which are already harming Hoosier farmers in rural 

communities. 

Let me tell you a conversation I had last Friday. It was with a 

businessman who is also a farmer, and he was telling me about he 

just bought 140 acres from another farmer. And he said, ‘‘Joe, I 

told the farmer, ‘I do not want to buy this from you right now because I know you are struggling. And I know you do not want to 

sell this. And I do not want to take advantage of you.’ ’’ 

And the farmer who was selling it said, ‘‘If I do not sell this, I 

could start losing everything else, and so you are actually helping 

me out.’’ This is where our rural economy is going right now. 

I have also heard from local businesses dealing with canceled orders because of the tariffs. The price of soybeans, as I mentioned, 

it is a 10-year low—a 10-year low—due largely to the Chinese tariffs on U.S. exports. This current policy, what I worry about is that 

it has already damaged foreign export markets that took decades 

and decades to build. And so what I am asking you is: What would 

be the long-term impact of falling commodity prices and reduced 

agriculture exports on rural communities, which are struggling in 

so many ways already? 

Mr. POWELL. Well, I think we know it would be very bad, and 

we have seen periods in American history where that has happened, and it can be extremely tough on farmers and rural communities. 

Senator DONNELLY. And if they lose the markets that they have 

developed—I was over in China talking to some of their defense 

leaders a few years ago about North Korea, and I was walking 

through the airport, and there was a group just by coincidence— 

it was a flight back home, the flight to Chicago and then go back 

home to Indiana. It was a group of Indiana soybean farmers who 

were traveling the country, developing the market. What happens 

to rural communities if China just looks up and says, you know, 

‘‘we found more reliable suppliers’’? 

Mr. POWELL. As we discussed, it can be very tough. 

Senator DONNELLY. So as Fed Chairman, what would you say to 

all those farmers who are really nervous, really concerned about 

what their future will be? They look to us for smart policies, for 

reasonable policies. Is there anything you can say about this trade 

war that is going on right now? 

Mr. POWELL. I should again start by saying that it is really not 

the Fed’s role. We do not do trade policy. That is Congress and the 

Administration. 

35 

But, you know, I think if the current process of negotiation back 

and forth results in lower tariffs, that would be a good thing for 

the economy. If it results in higher tariffs, then I think—you know, 

I hardly need to tell you what higher tariffs would do for agricultural producers. Agriculture is an area where we lead the world in 

productivity and we are great exporters, and, you know, you would 

be very hard hit by these tariffs. 

Senator DONNELLY. If this goes on for a couple more years, what 

would be the impact on our rural communities? 

Mr. POWELL. I think certainly it would be very tough on the 

rural communities and, you know, I think we would feel that at the 

national level, too. 

Senator DONNELLY. Let me also ask you about opioids, which you 

have mentioned, and workforce participation. My State has been 

deeply impacted by the opioid crisis. Last summer, during one of 

her final appearances before Congress, I spoke with former Chair 

Janet Yellen about the opioid epidemic and its connection to not 

just health outcomes but also economic and employment outcomes, 

the impact of opioids on the labor participation rate, which has declined from 66 to 63 percent over the last decade. She agreed there 

was a connection and noted surveys suggest that many prime-age 

individuals who are not actively participating in the labor market 

are involved in prescription drug use. 

You know, I look at these people we have lost, the next doctors, 

the next electricians, the next nurses. What do you see is the impact of the opioid epidemic on our workforce participation and, in 

general, the economy? 

Mr. POWELL. You know, it is a terrible human tragedy for many 

communities, certainly for the individuals and their families involved. I think from an economic standpoint, some high percentage 

of the prime-age people who are not in the labor force, particularly 

prime-age males who are not in the labor force, are taking painkillers of some kind. I think the number that Alan Krueger, who 

is a professor, came up with is 44 percent of them. So it is a big 

number. It is having a terrible human tool on our communities, 

and also it matters a lot for labor force participation and economic 

activity in our country. 

Senator DONNELLY. Thank you. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Thank you, Senator Donnelly. 

That concludes the questioning, but Senator Brown wants—— 

Senator BROWN. Thirty seconds, Mr. Chairman. Thank you. A 

number of colleagues have talked about productivity and nonsupervisory pay, that pay has gone up 27 percent and—I am sorry, 

2.7 percent, but it is important—from June to June, I think, was 

what one of my colleagues said. But it is important to recognize 

that CPI has gone up 3 percent in that period. So we should really 

never talk about nominal pay. We should talk about real dollar 

pay. 

Thank you, Mr. Chairman. 

Chairman CRAPO. Understood. All right. Thank you. And thank 

you, Mr. Chairman, again for being here. We appreciate your work 

and also your taking the time to come here and respond to our 

questions. 

36 

For Senators wishing to submit questions for the record, those 

questions are due in 1 week, on Tuesday, July 24th, and, Chairman 

Powell, we ask that you respond as promptly as you can to the 

questions that may come in. 

Again, we thank you for being here. This is very good timing. We 

have got a vote underway right now, so we appreciate you helping 

to steer this hearing to a good conclusion. 

With that, the hearing is adjourned. 

Mr. POWELL. Thank you. 

[Whereupon, at 11:53 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

37 

PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO 

Today, we welcome Chairman Powell back to the Committee for the Federal Reserve’s Semiannual Monetary Policy Report to Congress. 

This hearing provides the Committee an opportunity to explore the current state 

of the U.S. economy, and the Fed’s implementation of monetary policy and supervision and regulation activities. 

Since our last Humphrey–Hawkins hearing in March, Congress passed, with significant bipartisan support, and the President signed into law, S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. 

The primary purpose of the bill is to make targeted changes to simplify and improve the regulatory regime for community banks, credit unions, midsize banks, and 

regional banks to promote economic growth. 

A key provision of the bill provides immediate relief from enhanced prudential standards to banks with $100 billion in total assets or less. 

The bill also authorizes the Fed to provide immediate relief from enhanced pru- dential standards to banks with between $100 billion and $250 billion in assets. 

It is my hope that the Fed promptly provides relief to those within those thresholds. 

By right-sizing regulation, the bill will improve access to capital for consumers 

and small businesses that help drive our economy. 

And, the banking regulators are already considering this bill in some of their 

statements and rulemakings. 

Earlier this month, the Fed, FDIC and OCC issued a joint statement outlining 

rules and reporting requirements immediately impacted by the bill, including a separate letter issued by the Fed that was particularly focused on those impacting 

smaller, less complex banks. 

But, there is still much work to do on the bill’s implementation. 

As the Fed and other agencies revisit past rules and develop new rules in conjunction with the bill, it is my expectation that such rules be developed consistent with 

the purpose of the bill and intent of the members of Congress who voted for the 

bill. 

With respect to monetary policy, the Fed continues to monitor and respond to 

market developments and economic conditions. 

In recent comments at a European Central Bank Forum on Central Banking, 

Chairman Powell described the state of the U.S. economy, saying, ‘‘Today, most 

Americans who want jobs can find them. High demand for workers should support 

wage growth and labor force participation . . . Looking ahead, the job market is 

likely to strengthen further. Real gross domestic product in the United States is now 

reported to have risen 2.75 percent over the past four quarters, well above most estimates of its long-run trend . . . Many forecasters expect the unemployment rate 

to fall into the mid-3s and to remain there for an extended period.’’ 

According to the FOMC’s June meeting minutes, the FOMC meeting participants 

agreed that the labor market has continued to strengthen and economic activity has 

been rising at a solid rate. 

Additionally, job gains have been strong and inflation has moved closer to the 2 

percent target. 

The Fed also noted that the recently passed tax reform legislation has contributed 

to these favorable economic factors. 

I am encouraged by these recent economic developments, and look forward to seeing our bill’s meaningful contribution to the prosperity of consumers and households. 

As economic conditions continue to improve, the Fed faces critical decisions with 

respect to the level and trajectory of short-term interest rates and the size of its 

balance sheet. 

I look forward to hearing more from Chairman Powell about the Fed’s monetary 

policy outlook and the ongoing effort to review, improve and tailor regulations consistent with the Economic Growth, Regulatory Relief and Consumer Protection Act. 

PREPARED STATEMENT OF SENATOR SHERROD BROWN 

Thank you, Mr. Chairman. This week, the President went overseas, and sided 

with President Putin while denigrating critical American institutions, including the 

press, the intelligence community, and the rule of law. 

Our colleague Senator John McCain expressed clearly what every patriotic American thought, ‘‘No prior president has ever abased himself more abjectly before a tyrant. Not only did President Trump fail to speak the truth about an adversary; but 

speaking for America to the world, our president failed to defend all that makes us 

38 

1https://www.bls.gov/news.release/realer.nr0.htm 

who we are—a republic of free people dedicated to the cause of liberty at home and 

abroad. American presidents must be the champions of that cause if it is to succeed.’’ 

With our democratic institutions under threat, we cannot ignore what happened 

in Helsinki yesterday. But we must not lose sight of the other policies of this Administration—including the rollback of the rules put in place to prevent the next 

economic crisis. 

Mr. Powell, thank you for appearing before the Committee to discuss these policies. 

Just last week, a Federal Reserve official said, ‘‘There are definitely downside 

risks, but the strength of the economy is really pretty important at the moment. The 

fundamentals for the U.S. economy are very strong.’’ 

That may be true for Wall Street, but for most of America workers haven’t seen 

a real raise in years, young Americans drowning in student loan debt, families trying to buy their first home—the strength of the economy is an open question at best. 

Last month, former Fed Chair Ben Bernanke was very clear about the long-term 

impact of the tax cut and the recent bump in Federal spending when he said, ‘‘in 

2020 Wile E. Coyote is going to go off the cliff.’’ 

Last week, the San Francisco Fed released a study finding that the rosy forecasts 

of the tax bill are likely ‘‘overly optimistic.’’ It found that the bill’s boost to growth 

is likely to be well below projections—or as small as zero. It also suggested that 

these policies could make it difficult to respond to future economic downturns and 

manage growing Federal debt. 

And it’s not just the tax bill—the economic recovery hasn’t been evenly felt across 

the country, either. Mr. Chair, I’d like to enter into the record an article from the 

New York Times this weekend which talks about those families still struggling from 

the lack of meaningful raises and other job opportunities. 

While hours have increased a bit over the past year for workers as a whole, real 

hourly earnings have not. 1 And for production and nonsupervisory workers, hours 

are flat and pay has actually dropped slightly, according to the Bureau of Labor Statistics. 

The number of jobs created in 2017 was smaller than in each of the previous 4 

years. Some of the very companies that announced billions in buybacks and dividends are now announcing layoffs, shutting down factories, and offshoring more 

jobs. 

Some of the biggest buybacks are in the banking industry, assisted in part by the 

Federal Reserve’s increasingly lax approach to financial oversight. 

Earlier this month, as part of the annual stress tests, the Fed allowed the seven 

largest banks to redirect $96 billion to dividends and buybacks. This money might 

have been used to pay workers, reduce fees for consumers, protect taxpayers from 

bailouts, or be deployed to help American businesses. 

Three banks—Goldman Sachs, Morgan Stanley, and State Street—all had capital 

below the amount required to pass the stress tests, but the Fed gave them passing 

grades anyway. 

The Fed wants to make the tests easier next year. And Vice Chair Quarles has 

suggested he wants to give bankers more leeway to comment on the tests before 

they’re administered—that’s like letting the students help write the exam. 

The Fed is considering dropping the qualitative portion of the stress tests all together—even though banks like Deutsche Bank, Santander, Citigroup, HSBC, and 

RBS have failed on qualitative grounds before. 

That doesn’t even include the changes the Fed is working on after Congress 

passed S. 2155 to weaken Dodd–Frank, making company-run stress tests for the 

largest banks ‘‘periodic’’ instead of annual, and exempting more banks from stress 

tests altogether. 

Vice Chair Quarles has also made it clear that massive foreign banks can expect 

goodies, too. 

And on and on and on it goes. The regulators are loosening rules around big bank 

capital, dismantling the CFPB, ignoring the role of the FSOC, undermining the 

Volcker Rule, and weakening the Community Reinvestment Act. 

When banks are making record profits, we should be preparing the financial system for the next crisis, building up capital, investing in workers, and combating 

asset bubbles. 

And we should be turning our attention to bigger issues that don’t get enough attention, like how the value placed on work has declined in this country, and how 

our economy increasingly measures success only in quarterly earnings reports. 

39 

Much of that is up to Congress to address, but over the last 6 months, I have 

only seen the Fed moving in the direction of making it easier for financial institutions to cut corners, and I have only become more worried about our preparedness 

for the next crisis. 

I look forward to your testimony. Thank you. 

PREPARED STATEMENT OF JEROME H. POWELL 

CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

JULY 17, 2018 

Good morning. Chairman Crapo, Ranking Member Brown, and other Members of 

the Committee, I am happy to present the Federal Reserve’s semiannual Monetary 

Policy Report to the Congress. 

Let me start by saying that my colleagues and I strongly support the goals the 

Congress has set for monetary policy—maximum employment and price stability. 

We also support clear and open communication about the policies we undertake to 

achieve these goals. We owe you, and the public in general, clear explanations of 

what we are doing and why we are doing it. Monetary policy affects everyone and 

should be a mystery to no one. For the past 3 years, we have been gradually returning interest rates and the Fed’s securities holdings to more normal levels as the 

economy strengthens. We believe this is the best way we can help set conditions in 

which Americans who want a job can find one, and that inflation remains low and 

stable. 

I will review the current economic situation and outlook and then turn to monetary policy. 

Current Economic Situation and Outlook 

Since I last testified here in February, the job market has continued to strengthen 

and inflation has moved up. In the most recent data, inflation was a little above 

2 percent, the level that the Federal Open Market Committee, or FOMC, thinks will 

best achieve our price stability and employment objectives over the longer run. The 

latest figure was boosted by a significant increase in gasoline and other energy 

prices. 

An average of 215,000 net new jobs were created each month in the first half of 

this year. That number is somewhat higher than the monthly average for 2017. It 

is also a good deal higher than the average number of people who enter the work 

force each month on net. The unemployment rate edged down 0.1 percentage point 

over the first half of the year to 4.0 percent in June, near the lowest level of the 

past two decades. In addition, the share of the population that either has a job or 

has looked for one in the past month—the labor force participation rate—has not 

changed much since late 2013. This development is another sign of labor market 

strength. Part of what has kept the participation rate stable is that more workingage people have started looking for a job, which has helped make up for the large 

number of baby boomers who are retiring and leaving the labor force. 

Another piece of good news is that the robust conditions in the labor market are 

being felt by many different groups. For example, the unemployment rates for African Americans and Hispanics have fallen sharply over the past few years and are 

now near their lowest levels since the Bureau of Labor Statistics began reporting 

data for these groups in 1972. Groups with higher unemployment rates have tended 

to benefit the most as the job market has strengthened. But jobless rates for these 

groups are still higher than those for whites. And while three-fourths of whites responded in a recent Federal Reserve survey that they were doing at least okay financially in 2017, only two-thirds of African Americans and Hispanics responded 

that way. 

Incoming data show that, alongside the strong job market, the U.S. economy has 

grown at a solid pace so far this year. The value of goods and services produced in 

the economy—or gross domestic product—rose at a moderate annual rate of 2 percent in the first quarter after adjusting for inflation. However, the latest data suggest that economic growth in the second quarter was considerably stronger than in 

the first. The solid pace of growth so far this year is based on several factors. Robust 

job gains, rising after-tax incomes, and optimism among households have lifted consumer spending in recent months. Investment by businesses has continued to grow 

at a healthy rate. Good economic performance in other countries has supported U.S. 

exports and manufacturing. And while housing construction has not increased this 

year, it is up noticeably from where it stood a few years ago. 

I will turn now to inflation. After several years in which inflation ran below our 

2 percent objective, the recent data are encouraging. The price index for personal 

consumption expenditures, which is an overall measure of prices paid by consumers, 

40 

increased 2.3 percent over the 12 months ending in May. That number is up from 

1.5 percent a year ago. Overall inflation increased partly because of higher oil 

prices, which caused a sharp rise in gasoline and other energy prices paid by consumers. Because energy prices move up and down a great deal, we also look at core 

inflation. Core inflation excludes energy and food prices and generally is a better 

indicator of future overall inflation. Core inflation was 2.0 percent for the 12 months 

ending in May, compared with 1.5 percent a year ago. We will continue to keep a 

close eye on inflation with the goal of keeping it near 2 percent. 

Looking ahead, my colleagues on the FOMC and I expect that, with appropriate 

monetary policy, the job market will remain strong and inflation will stay near 2 

percent over the next several years. This judgment reflects several factors. First, interest rates, and financial conditions more broadly, remain favorable to growth. Second, our financial system is much stronger than before the crisis and is in a good 

position to meet the credit needs of households and businesses. Third, Federal tax 

and spending policies likely will continue to support the expansion. And, fourth, the 

outlook for economic growth abroad remains solid despite greater uncertainties in 

several parts of the world. What I have just described is what we see as the most 

likely path for the economy. Of course, the economic outcomes we experience often 

turn out to be a good deal stronger or weaker than our best forecast. For example, 

it is difficult to predict the ultimate outcome of current discussions over trade policy 

as well as the size and timing of the economic effects of the recent changes in fiscal 

policy. Overall, we see the risk of the economy unexpectedly weakening as roughly 

balanced with the possibility of the economy growing faster than we currently anticipate. 

Monetary Policy 

Over the first half of 2018 the FOMC has continued to gradually reduce monetary 

policy accommodation. In other words, we have continued to dial back the extra 

boost that was needed to help the economy recover from the financial crisis and recession. Specifically, we raised the target range for the Federal funds rate by 1⁄4 percentage point at both our March and June meetings, bringing the target to its current range of 13⁄4 to 2 percent. In addition, last October we started gradually reducing the Federal Reserve’s holdings of Treasury and mortgage-backed securities. That 

process has been running smoothly. Our policies reflect the strong performance of 

the economy and are intended to help make sure that this trend continues. The payment of interest on balances held by banks in their accounts at the Federal Reserve 

has played a key role in carrying out these policies, as the current Monetary Policy 

Report explains. Payment of interest on these balances is our principal tool for keeping the Federal funds rate in the FOMC’s target range. This tool has made it possible for us to gradually return interest rates to a more normal level without disrupting financial markets and the economy. 

As I mentioned, after many years of running below our longer-run objective of 2 

percent, inflation has recently moved close to that level. Our challenge will be to 

keep it there. Many factors affect inflation—some temporary and others longer lasting. Inflation will at times be above 2 percent and at other times below. We say 

that the 2 percent objective is ‘‘symmetric’’ because the FOMC would be concerned 

if inflation were running persistently above or below our objective. 

The unemployment rate is low and expected to fall further. Americans who want 

jobs have a good chance of finding them. Moreover, wages are growing a little faster 

than they did a few years ago. That said, they still are not rising as fast as in the 

years before the crisis. One explanation could be that productivity growth has been 

low in recent years. On a brighter note, moderate wage growth also tells us that 

the job market is not causing high inflation. 

With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that—for now—the best way forward is 

to keep gradually raising the Federal funds rate. We are aware that, on the one 

hand, raising interest rates too slowly may lead to high inflation or financial market 

excesses. On the other hand, if we raise rates too rapidly, the economy could weaken 

and inflation could run persistently below our objective. The Committee will continue to weigh a wide range of relevant information when deciding what monetary 

policy will be appropriate. As always, our actions will depend on the economic outlook, which may change as we receive new data. 

For guideposts on appropriate policy, the FOMC routinely looks at monetary policy rules that recommend a level for the Federal funds rate based on the current 

rates of inflation and unemployment. The July Monetary Policy Report gives an update on monetary policy rules and their role in our policy discussions. I continue 

to find these rules helpful, although using them requires careful judgment. 

Thank you. I will now be happy to take your questions. 

41 

1For more information about the Financial Services Pipeline initiative, go to: https:// 

www.fspchicago.org/. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM JEROME H. POWELL 

Q.1. In response to questions at your confirmation hearing on Federal Reserve efforts to increase diversity in the System, you said, 

‘‘I assure you that diversity will remain a high priority objective for 

the Federal Reserve. Reserve banks, working closely with the 

Board, have also been looking at ways to further develop a diverse 

pool of talent in a thoughtful, strategic fashion, readying them for 

leadership roles through the Federal Reserve System.’’ 

Since you have become chair, what specific steps have you taken 

to encourage more diversity in the Federal Reserve System? 

A.1. The Federal Reserve System (System) needs people with a variety of personal and professional backgrounds to be fully effective 

in discharging its responsibilities, and we have observed that better decisions are made when there are many different perspectives 

represented around the table. Since 2016, my colleagues and I on 

the Federal Reserve Board (Board) have implemented a framework 

to better understand and discuss a range of Board and System efforts that address diversity and inclusion as well as research on 

economic inclusion and economic disparities in the economy. Since 

becoming the Chairman in February, I have worked with Board 

staff to refresh the framework and prioritize our focus on diversity 

and economic inclusion initiatives both at the Board and elsewhere 

in the System and have ongoing discussions with staff, including 

the Board’s Office of Minority and Women Inclusion (OMWI) Director, on ways to support various efforts. 

I continue to stress to Federal Reserve leaders and staff the importance of having a diverse workforce and providing an inclusive 

work environment to our people. System leaders have fostered a 

range of diversity and inclusion initiatives, including the development of leadership pipelines and ongoing engagements with our 

own staff and with the financial services, economic, and academic 

communities more broadly. Of the various efforts, I would like to 

highlight the following: 

• The System launched a leadership development initiative to 

provide a structured way to share information about our talent 

pool and to find opportunities throughout the System to more 

rapidly grow our talent and prepare them to take on expanded 

roles. 

• Through the Financial Services Pipeline Initiative, 1 the Federal Reserve Bank of Chicago is working to increase the representation of people of color in the financial services industry 

in the Chicago region. Over the last several months, the Reserve Bank of Chicago has hosted events designed to develop 

leadership skills for high-performing people of color. 

• Researchers throughout the System continue to produce cutting-edge research on how and why disparities exist for different demographic groups in their experiences in employment, 

education, and health, and in the housing and credit markets. 

In addition, seminars and panels about diversity and inclusion 

42 

2For more information about the Opportunity & Inclusive Growth Institute, go to: https:// 

www.minneapolisfed.org/institute. 3The conference program and discussion materials are available on the Bank of England’s 

website at: https://www.bankofengland.co.uk/events/2018/may/gender-and-career-progression. 4For more information about the Exploring Careers in Economics event, go to https:// 

www.federalreserve.gov/newsevents/pressreleases/other20180823a.htm. 

topics are being fostered by local leadership and employee resource networks and are shared across the System. 

• Through the Opportunity & Inclusive Growth Institute, 2 the 

Reserve Bank of Minneapolis is conducting research on structural barriers that limit full participation in economic opportunity and advancement in the country. The Institute looks beyond aggregate economic indicators in order to examine how 

national policies impact diverse communities of people within 

the U.S. economy. 

• The Board cosponsored a Gender and Career Progression 3 conference with the European Central Bank and the Bank of England in May of this year. There were about 140 people in attendance, including participants from central banks, academia, 

think tanks, private industry, as well as a number of local students. The topics and papers from the conference focused on 

gender diversity in economics, finance, and central banking, including gender-based discrimination, the benefits of increased 

diversity, the role of culture, and the approaches that could be 

used to improve gender diversity. We continue to explore ways 

to leverage the knowledge gained from this event for the 

Board, the System, and the broader economic community. The 

Board subsequently held a panel discussion for its employees 

sharing key insights from the conference. 

• Throughout the System, we continue to increase our outreach 

to local universities, with a particular focus on outreach to 

under-represented groups. The Board will soon be hosting Exploring Careers in Economics, 4 an event for high school and 

college students, in October. Organized to broaden awareness 

of careers in economics and to further develop a diverse pool 

of talent interested in the field, Exploring Careers in Economics will offer students a chance to learn about and discuss opportunities in economics generally, and learn about mentoring 

opportunities, resources, and career opportunities within the 

System. The agenda includes a discussion of why inclusion and 

diversity matter for economics. In addition to welcoming students to the Board in Washington, students from around the 

country will participate in this event via webcast. 

• The Board’s OMWI Office, in collaboration with the OMWI Directors from the Office of the Comptroller of the Currency 

(OCC), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), and Consumer Financial Protection Bureau (CFPB) (collectively, the Agencies), 

hosted a Diversity and Inclusion Summit (Summit) on September 13 at the Federal Reserve Bank of New York for the 

institutions regulated by each regulatory agency. The primary 

purpose of the Summit was for the Agencies’ OMW is to provide feedback on submissions received from regulated entities 

responding to the questionnaire developed through the Policy 

43 

Standards for Assessing Diversity Policies and Practices pursuant to section 342 of the Dodd–Frank Wall Street Reform and 

Consumer Protection Act (Dodd–Frank Act). Additionally, an 

important aspect of the Summit was the dialogue and insights 

between representatives from the regulated entities and the 

OMWI Directors on leading diversity practices. 

Q.2. In your role as the head of the Reserve Bank Affairs Committee and now as Chair of the Board of Governors of the Federal 

Reserve System, did you ever ask the search committees in Atlanta, Richmond, or New York for a lists of candidates under consideration? At any point did you urge the search committees at any 

of the Banks to broaden their searches to include more women or 

minority candidates? 

A.2. As the Chair of the Reserve Bank Affairs Committee, I had 

worked closely with the search committees to ensure a strong and 

transparent process that identifies a broad and diverse slate of 

qualified candidates for president searches. Now as Chairman of 

the Board, I continue to work closely with my colleague Lael 

Brainard, Chair of the Reserve Bank Affairs Committee, to exercise 

the Board’s oversight responsibility and stress the importance of 

conducting a broad search throughout the search process. We also 

recognize that the appointment of a president is, as a legal matter, 

a responsibility of the Class Band Class C directors. 

During the recent Reserve Bank president searches, the search 

committees proactively sought out candidates from a variety of 

sources. The search committees have also carried out extensive outreach programs intended to solicit input and candidate recommendations from a range of constituencies across the districts. 

These engagement efforts were done with the goal of having as 

broad and diverse of candidate pools as possible for the searches. 

Throughout the search process, the chair of the search committee 

typically provides status updates, including information about the 

candidate pools, and discusses potential candidates with the Chair 

of the Reserve Bank Affairs Committee. 

Q.3. What is your role, directly and indirectly, in the San Francisco 

Federal Reserve Bank’s search to select its next President? 

A.3. The San Francisco Fed announced the appointment of Mary 

Daly as its new president on September 14. As Chairman of the 

Board, I stayed abreast of the search through the Chair of the Reserve Bank Affairs Committee. When the search committee settled 

on the finalist, my colleagues and I at the Board interviewed Ms. 

Daly. Upon final approval by all Class B and Class C directors of 

the Federal Reserve Bank of San Francisco, my colleagues and I 

at the Board voted on the Bank board’s request for approval of the 

appointment of Ms. Daly as the new president for the Reserve 

Bank. 

Q.4. Recently proposed legislation would override the Securities 

and Exchange Commission’s (SEC) 2014 reforms to money market 

funds. Specifically, that legislation would permit sponsors of money 

market funds that satisfy certain conditions to utilize a stable net 

asset value, or NAV. In addition, the proposal would exempt those 

funds from the liquidity fee requirements in the SEC’s rules. 

44 

5Former Fed Chair Yellen cited research noting that ‘‘research points to benefits from capital 

requirements in excess of those adopted.’’ See remarks by Chair Janet L. Yellen. ‘‘Financial Stability a Decade After the Onset of the Crisis’’. Speech at the ‘‘Fostering a Dynamic Global Recovery’’ Symposium Sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 25, 2017. Available at: https://www.federalreserve.gov/newsevents/speech/ 

yellen20170825a.htm; Firestone, Simon, Amy Lorenc, and Ben Ranish, ‘‘An Empirical Economic 

Assessment of the Costs and Benefits of Bank Capital in the U.S.’’, Board of Governors of the 

Federal Reserve System, 2017. Available at: https://www.federalreserve.gov/econres/feds/files/ 

2017034pap.pdf; Federal Reserve Bank of Minneapolis, ‘‘The Minneapolis Plan To End Too Big 

To Fail’’, December 2017. Available at: https://www.minneapolisfed.org/-/media/files/publications/studies/endingtbtf/the-minneapolis-plan/the-minneapolis-plan-to-end-too-big-to-failfinal.pdf?la=en. 

As you know, the SEC’s 2014 reforms require institutional money 

market funds investing in corporate or municipal debt securities to 

use a floating NAV and provide nongovernment money market 

fund boards with new tools—liquidity fees and redemption gates— 

to prevent runs. Those mechanisms are intended to prevent runs 

on money market funds and the freezing of the short-term liquidity 

market that occurred during the financial crisis. 

Nellie Liang, who served for 11 years in senior roles at the Federal Reserve in the Division of Financial Stability and the Division 

of Research and Statistics, recently wrote an article titled, ‘‘Why 

Congress shouldn’t roll back the SEC’s money market rules’’ (attached). 

Ms. Liang’s article explains the market dislocation that occurred 

during the crisis that led to the SEC’s implementation of the 2014 

reforms. Ms. Liang highlights several important improvements to 

the structure of money funds, explaining that during the crisis 

‘‘there was no doubt that the structure of prime MMF’s amplified 

losses and spread problems to many companies when their investors ran.’’ She concludes that the ‘‘post crisis rules aim not only to 

prevent a repeat of the last crisis but to reduce the probability and 

costs of the next one,’’ and that, ‘‘reverting to precrisis rules would 

risk a return to high levels of private short-term liabilities and another destabilizing run on money market funds, and threaten stability in the financial system and the economy as a whole’’. 

Do you agree with Ms. Liang’s concerns that reverting to 

precrisis rules could create vulnerabilities in the stability of the financial system? 

A.4. Susceptibility of money market funds (MMFs) to runs was a 

significant vulnerability and flashpoint in the U.S. financial system 

during the financial crisis and afterwards. The run on MMFs in 

September 2008 destabilized wholesale funding markets used by 

banks, dealers, nonfinancial firms, and municipalities for shortterm financing. The Securities and Exchange Commission’s (SEC) 

reforms were designed to mitigate these risks. In part due to these 

regulatory changes, funding markets have undergone significant 

shifts; while markets have largely adjusted to these shifts, considering additional changes at this moment would likely be unhelpful 

to the funding markets. 

Q.5. In your testimony, you noted that the banking industry is 

well-capitalized. Recent research from the Fed system suggests 

that large banks may hold less capital than is optimal in terms of 

balancing the cost of another financial crisis with any incremental 

increase in bank lending rates. 5

45 

What do you think of this research? Do G–SIBs need to hold additional capital? 

A.5. 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. These firms must be well-capitalized in order to be considered safe and sound. Accordingly, the U.S. 

banking agencies have substantially strengthened regulatory capital requirements for large banking firms, thereby improving the 

quality and increasing the amount of capital in the banking system. From before the crisis to today, large U.S. banking firms have 

roughly doubled their capital positions, making them significantly 

more resilient, as well as able to support lending and financial 

intermediation in times of financial stress. 

Firestone et al., the staff working paper that you cite, analyzes 

aggregate capital levels across the U.S. banking sector and does not 

address targeted capital requirements that apply to specific banks. 

A firm identified as a global systematically important bank (G– 

SIB) is currently subject to more stringent capital requirements 

than those required of other, less systemic firms. 

Under the Federal Reserve’s final G–SIB surcharge rule, a G– 

SIB is required to hold an additional amount of risk-based capital 

that is calibrated to its overall systemic risk as well as an additional supplementary leverage ratio buffer of 2 percent above the 

3 percent minimum in order to avoid restrictions on distributions 

and certain discretionary bonus payments. G–SIBs, together with 

certain other large banks, also are subject to annual examination 

of capital planning practices through the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) and to a supervisory stress test. Finally, G–SIBs are required to maintain minimum levels of unsecured, long-term debt and total loss-absorbing 

capacity (TLAC), which is made up of both capital and long-term 

debt, in order to further help reduce the systemic impact of the failure of a G–SIB. The purpose of these more stringent requirements 

is to increase a G–SIB’s resiliency in light of the greater threat it 

poses to U.S. financial stability. This capital regulatory framework 

is designed to ensure that G–SIBs, as well as the banking industry 

as a whole, maintain strong capital positions. 

Q.6. When asked at the July 17 hearing about your plans to implement S. 2155, you said it is your intention ‘‘implement the bill as 

quickly as we possibly can.’’ Does that mean you are going to move 

to the rulemakings and implementation of S. 2155 before you finish 

the remaining unfinished rulemakings required by the Wall Street 

Reform and Consumer Protection Act enacted 8 years ago? 

A.6. Many of Economic Growth, Regulatory Relief, and Consumer 

Protection Act’s (EGRRCPA) changes require amendments to existing rules. The Board is working expeditiously on these rulemakings 

and plans to solicit public comment on the proposed rule changes. 

EGRRCPA includes a number of statutory deadlines for implementing certain sections of the law. It is our intention to prioritize 

rulemakings with statutory deadlines in order to ensure that the 

Board’s rules are compliant with the law in the timeframe mandated by Congress. 

46 

The Board has implemented the majority of its assigned provisions from the Dodd–Frank Act. Sections of EGRRCPA, along with 

the remaining unimplemented sections of the Dodd–Frank Act, 

which do not have statutory deadlines, may take longer to complete. 

Q.7. Does the Fed view any provisions in S. 2155 as providing a 

statutory requirement to revisit or recalibrate the enhanced prudential standards applicable to bank holding companies with more 

than $250 billion in total consolidated assets? 

A.7. One of the fundamental lessons from the financial crisis was 

that the largest, most interconnected financial firms needed to 

maintain substantially more capital, take substantially less liquidity risk, and face an effective orderly resolution regime if they fail. 

Firms with assets of $250 billion or more can present a range of 

safety and soundness and financial stability concerns. Therefore, 

the Board has tailored, and will continue to tailor, as appropriate, 

our regulations to the risk profiles of the firms subject to those regulations. 

In light of EGRRCPA’s amendments, and consistent with the 

Board’s ongoing refinement and evaluation of its supervisory program, the Board is evaluating whether any changes to the enhanced prudential standards applicable to bank holding companies 

with more than $250 billion in total consolidated assets are appropriate. In doing so, the Board will consider individual firms’ capital 

structure, riskiness, complexity, financial activities (including the 

financial activities of their subsidiaries), size, and any other riskrelated factors that the Board deems appropriate, as provided in 

EGRRCPA. 

Q.8. Either pursuant to S. 2155 or pursuant to other authority conferred to the Fed, does the Board intend to alter the threshold at 

which foreign banking organizations must establish a U.S. Intermediate Holding Company? Does the Fed intend to provide any 

regulatory relief to foreign banking organizations that have more 

than $50 billion in domestic assets? If so, what regulatory relief is 

the Fed planning to propose? 

A.8. Pursuant to the Board’s regulations, foreign bank organizations (FBOs) with global assets of at least $100 billion and U.S. 

nonbranch assets of at least $50 billion are required to establish 

or designate a U.S. intermediate holding company (IHC). In our supervisory experience, the requirement to establish an IHC has 

worked effectively, providing for appropriate application of capital, 

liquidity, and other prudential requirements across the U.S. nonbranch operations of the FBO, as well as a single nexus for risk 

management of those U.S. nonbranch operations. The Board presently sees no reason to modify this threshold. We continue to review our regulatory framework to improve the manner in which we 

deal with the particular risks of FBOs in light of the distinct characteristics of such institutions. 

Q.9. Does the Fed have any economic evidence suggesting that the 

recently enacted tax bill, S. 2155, or any deregulation finalized by 

regulators since 2017 has benefited the overall economy through increased lending? 

47 

A.9. Economic conditions remain strong. Gross domestic product 

growth thus far this year is estimated to have averaged a little 

above 3 percent at an annual rate. Households and businesses have 

been able to obtain the financing needed to support this growth. Financial institutions are well-positioned to meet the needs of borrowers. However, it is too early to determine the economic effects 

of the tax bill or recently implemented changes in regulation. Generally speaking, it is difficult to isolate the effects of such changes 

given the myriad factors influencing the economy. 

Q.10. Does the Fed intend to revisit the calculation of the G–SIB 

surcharge? If so, when and in what ways? 

A.10. The Board’s capital rules have been designed to reduce significantly the likelihood 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. Consistent with these principles, the Board originally calibrated the G–SIB surcharge so that—given the circumstances of the financial system—each G–SIB would hold 

enough capital to lower its probability of failure so that the expected impact of its failure on the financial system would be approximately equal to that of a large non- G–SIB. 

The bulk of the postcrisis regulation is largely complete, with the 

exception of the U.S. implementation of the recently concluded 

Basel Committee agreement on bank capital standards. It is therefore a natural and appropriate time to step back and assess those 

efforts. The Board is conducting a comprehensive review of the regulations in the core areas of postcrisis reform, including capital, 

stress testing, liquidity, and resolution. The objective of this review 

is to consider the effect of those regulatory frameworks on the resiliency of the financial system, including improvements in the resolvability of banking organizations, and on credit availability and economic growth. 

In general, I believe overall capital for our largest banking organizations is at about the right level. Critical elements of our capital 

structure for these organizations include stress testing, the stress 

capital buffer, and the enhanced supplementary leverage ratio. 

Work is underway to finalize the calibration of these fundamental 

building blocks, all of which form part of the system in which the 

G–SIB surcharge has an effect. In this regard, I would note that 

the G–SIB surcharge rule does not take full effect until January 

2019. 

Q.11. When does the Fed intend to finalize a 2016 proposed rulemaking related to bank holding companies’ allowable activities in 

physical commodities markets? 

A.11. The Board undertook a review of the physical commodities 

activities of financial holding companies after a substantial increase in these activities during the financial crisis. In January 

2014, the Board invited public comment on a range of issues related to these activities through an advance notice of proposed ruleVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00051 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
48 

5Public Law 111-203, 124 Stat. 1376 (2010). 

6 75 Federal Register 36395. 

making. In response, the Board received a large number of comments from a variety of perspectives. 

The Board considered those comments in developing the proposed 

rulemaking that was issued in September 2016. The proposed rulemaking would address the potential catastrophic, legal, and 

reputational risks of financial holding companies’ (FHC) physical 

commodities activities by applying additional risk-based capital requirements to some of these activities; tightening some of the existing limitations on physical commodities trading by FHCs; and establishing new reporting requirements for physical commodities 

holdings and activities of FHCs. Under the proposal, FHCs would 

be permitted to continue to engage in a number of physical commodities trading activities with end users subject to new limits on 

physical commodities trading activities. 

After providing an extended comment period (150 days) to allow 

comm enters time to understand and address the important and 

complex issues raised by the proposal, the Board again received a 

large number of comments from a variety of perspectives, including 

Members of Congress, academics, users and producers of physical 

commodities, and banking organizations. The Board continues to 

consider the proposal in light of the many comments received. 

Q.12. At the July 17 hearing, when asked when the Fed will finalize the rulemaking required under Dodd–Frank related to incentive-based compensation at large bank holding companies, you stated that the interagency regulators have been unable to reach consensus and that the Fed has accomplished some of the goals of the 

rulemaking through the supervisory process. 

Please provide specific examples. 

A.12. Section 956 of the Dodd–Frank Act 5 prohibits incentivebased compensation arrangements that encourage inappropriate 

risks. Federal Reserve staff have worked with firms in the implementation of the 2010 Federal Banking Agency Guidance on Sound 

Incentive Compensation Policies, 6 a core principle of which is that 

incentive compensation should appropriately balance risk and reward. In so doing, Federal Reserve staff have observed improvement in incentive compensation practices in the following areas: 

• Risk adjustment: Firms have increasingly begun adjusting 

compensation to more appropriately take into account the risk 

an employee’s activities may pose to the organization, including through use of deferral and forfeiture features in compensation arrangements. Firms also have increasingly focused 

on nonfinancial risk (e.g., compliance failures, misconduct, and 

operational challenges) in risk adjustment decisions. 

• Involvement of risk management and control personnel: Risk 

management and control personnel generally play a greater 

role in the design and operation of incentive compensation programs than before the financial crisis. 

• Director oversight: Boards of directors are now increasingly focused on the relationship between incentive compensation and 

risk. For example, at the board level, finance and audit comVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00052 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
49 

mittees generally work together with compensation committees 

with the goal of promoting prudent risk-taking. 

• Policies and procedures: Firms have increasingly developed 

written policies and procedures to guide managers in making 

appropriate risk adjustments. 

Q.13. What is the your view on the Fed’s role as the consolidated 

Federal regulator for insurance companies that have a savings and 

loan holding company? 

A.13. The Federal Reserve is charged with consolidated supervision 

of savings and loan holding companies to promote the safety and 

soundness of the subsidiary insured depository institution (IDI) 

and the holding company. Our principal supervisory objectives for 

consolidated supervision of insurance savings and loan holding 

companies (ISLHCs) are to ensure that they operate in a safe-andsound manner so that the subsidiary insured depository institution 

is protected from risks related to nonbanking activities, including 

insurance, as well as intercompany transactions between the parent and IDI, and to ensure that the IDI is not adversely affected. 

To avoid duplication, we rely on the State insurance departments 

to the greatest extent possible, including their supervision of the 

business of insurance. In applying our consolidated supervision, we 

work to ensure that regulations, supervisory guidance, and expectations are appropriately tailored to account for the unique complexities and characteristics of ISLHCs. We remain committed to 

tailoring our supervision of ISLHCs to the firms and their insurance operations, as well as conducting our consolidated supervision 

of these firms in coordination with State insurance regulators. 

Moreover, the Board continues to welcome feedback from ISLHCs 

and other interested parties on the potential impact of our supervision and proposed rulemakings in the context of ISLHCs’ business and practices. 

Q.14. Vice Chair Quarles recently gave a speech suggesting that 

the Fed should ‘‘consider scaling back or removing entirely resolution planning requirements for most of the firms’’ in the $100 billion to $250 billion total consolidated asset range. Please describe 

further the Fed’s plans in this regard, along with any cost-benefit 

analysis suggesting that the economy would benefit from such a 

change. 

How does the Fed view the directive in S. 2155 that companyrun and certain supervisory stress tests be made ‘‘periodic’’ rather 

than semi-annual or annual? Does the Fed anticipate changing the 

frequency of stress tests for banks with more than $250 billion in 

total consolidated assets? 

A.14. Consistent with the Economic Growth, Regulatory Relief, and 

Consumer Protection Act (EGRRCPA), the Board is considering the 

application of enhanced prudential standards, including resolution 

planning requirements, to firms in the $100 billion to $250 billion 

total consolidated assets range. Resolution planning is especially 

critical to ensure that the largest, most complex, and most interconnected banking firms structure their operations in ways that 

make it more possible for them to be resolved upon failure without 

causing systemic risks for the broader economy. The Board therefore anticipates focusing resolution planning requirements on these 

50 

firms. Firms with total assets between $100 billion and $250 billion, especially those that are less complex and less interconnected, 

do not pose a high degree of resolvability risk. Therefore, we should 

consider no longer imposing the resolution planning requirement 

on at least a subset of the firms with total assets between $100 billion $250 billion. The Board will solicit feedback, including feedback on costs and benefits, on any proposed changes to the applicability of resolution planning requirements through the public notice 

and comment process. 

The provisions of EGRRCPA are generally consistent with the 

Board’s view that supervision and regulation should be appropriately tailored to the risks posed by firms to the financial system. 

The Board also recognizes that the complexity of banks can vary 

significantly from bank to bank, even for institutions within the 

$100 billion to $250 billion group. Those banks, which provide a 

significant amount of credit to the economy, range from large regional banks to an institution that has been designated a systemically important financial institution given its size and complexity. 

That suggests we may need to consider factors beyond size when 

we consider whether it is appropriate to reduce the frequency of 

the stress test. 

Pursuant to the provisions of EGRRCPA, the Board will assess 

the necessary and appropriate frequency of supervisory and company-run stress tests to effectively ensure the safety, soundness, 

and resiliency of the financial system while concurrently minimizing regulatory burden. In general, firms that pose limited risk 

to financial stability would be expected to be subject to less frequent supervisory and company-run stress tests than those with a 

large systemic footprint. Of course, we would invite public comment 

on any proposal to change the frequency of the stress test. 

Q.15. Does the Fed intend to exempt any firms from the requirement to calculate risk-weighted assets according to Advanced Approaches? 

A.15. The Board is currently focused on ways to simplify the existing capital rules and to reduce any unwarranted complexity of the 

applicable capital requirements overall, rather than on considering 

exemptions for particular firms. The Board believes there is room 

to simplify the capital framework, while preserving the stringency 

of the overall capital requirements. The Board is also actively reviewing the requirements applicable to firms with more than $250 

billion in total assets to make sure they are appropriately tailored 

to the firms to which they are applied. 

Q.16. How does the Fed’s planned rulemaking regarding ‘‘reach 

back’’ application of enhanced prudential standards anticipate expeditiously capturing quickly growing firms whose risk to the economy may rapidly escalate? For example, Countrywide grew from 

$26 billion in total consolidated assets in 2000 to $211 billion in 

2007, and posed systemic threat to the economy. 

A.16. EGRRCPA tailors supervisory requirements to the size and 

complexity of banking organizations. As is reflected in EGRRCPA, 

regulations should be the most stringent for the largest and most 

complex institutions. Rulemakings proposed by the Board to tailor 

existing requirements would be designed to maintain a safe, sound, 

51 

and stable banking system that supports economic growth without 

imposing unnecessary costs. Under this principle, if a bank grows 

in size and complexity, the Board’s regulatory framework would 

apply increasingly stringent requirements to that banking organization commensurate with the organization’s size and complexity. 

Q.17. In what ways, if any, does the Fed intend to revamp the 

Community Reinvestment Act (CRA)? 

A.17. The Federal Reserve supports modernizing the Community 

Reinvestment Act (CRA) regulations so that they better reflect 

structural and technological changes in the banking industry and 

strengthen the rules to help address the credit needs of low- and 

moderate-income communities. We think an Advance Notice of Proposed Rulemaking (ANPR) is a good starting point to gather input 

on the impact of the significant advancements in technology and 

other changes in the financial services marketplace since the regulations were last revised. We value input from all stakeholders on 

the impact of the significant advancements in technology and other 

changes in the financial services marketplace since the regulations 

were last revised. We look forward to reviewing suggestions that 

result from the OCC’s ANPR on possible refinements to CRA regulations. 

While there are many positive aspects of the current regulations, 

we believe that there are opportunities to improve clarity and consistency through modernization efforts, which would benefit both 

banks and the communities they serve. The Board also believes 

that revised regulations should recognize that banks vary widely in 

size and business strategy and serve communities with different 

credit needs. An interagency modernization process is also an opportunity to define ways to evaluate a bank’s CRA performance in 

light of its size, business strategy, capacity, and constraints, as well 

as its community’s demographics, economic conditions, and credit 

needs and opportunities. To this end, more metrics could provide 

clarity. It is important that the use of metrics is sufficiently responsive to local credit needs and account for differences in performance expectations based on a bank’s size, business model, and 

strategy. 

The Board values the interagency process, and we look forward 

to working with the OCC and the FDIC on any regulatory revisions 

that would promote consistency in the implementation of CRA 

across the industry, as well as offer the greatest impact to benefit 

reinvestment in local communities, consistent with the spirit and 

intent of the law. 

Q.18. Assessment Areas under CRA are geographical areas where 

bank performance is evaluated on CRA exams. Currently, these 

areas include bank branches and deposit-taking ATMs. Many 

banks are making loans outside of branch networks, using alternative delivery channels including the Internet. 

Has the Federal Reserve given thought to changing the definition 

of Assessment Areas to reflect the changing landscape of banking? 

A.18. Yes. The central focus of the law is on a bank’s affirmative 

obligation to meet the credit needs of the communities it serves, including low- and moderate-income communities, consistent with 

safe-and-sound lending. The Board believes it is time to modernize 

52 

the regulations, including making changes to the definition of a 

bank’s ‘‘assessment area,’’ in which its CRA performance is evaluated. 

The banking environment has changed significantly since CRA’s 

enactment and since the current CRA regulation was adopted. The 

regulation focuses on assessing performance where banks have 

branches, but many banks may now serve consumers in areas far 

from their physical branches. Therefore, the Board agrees that it 

is sensible for the agencies to consider expanding the assessment 

area definition to reflect the various ways a bank can serve local 

communities, while retaining the core focus on place. 

Q.19. Comptroller Otting, during Committee testimony in June, 

suggested reducing CRA performance measurement to a simple formula system comparing the sum of CRA activities to bank assets. 

Making this ratio the totality of a CRA exam would abandon current examination weights which judge certain activities as more 

important than others, based on local needs. 

Do you support this single ratio approach? 

A.19. We support updating the CRA regulations to make them 

more effective in making credit available in low- and moderate-income areas. In enforcing CRA, we have identified principles to 

guide our work. For example, the Board believes that revised regulations should be tailored recognizing that banks vary widely in 

size and business strategy and serve communities with widely 

varying needs. We believe this can be done while retaining the 

flexibility to evaluate a bank’s CRA performance in light of its size, 

business strategy, capacity, and constraints as well as its community’s demographics, economic conditions, and credit needs and opportunities. 

We recognize the importance of considering the ways in which a 

bank’s business strategy, no matter its size, influences the types of 

activities it undertakes to meet its CRA obligations. 

53 


71718101.eps

Why Congress shouldn '1 roll back !he SEC's money marl< <I rules hlq>s:/lwww.brooking;.<dulbloglup-fionii2018/0I/121why-<Oilgress-shou ... 

I ofS 

BROOKINGS 

Why Congress shouldn't roll back the SEC's money market 

rules 

Nellie Liang Friday, January 12, 2018 

t the height of the financial crisis in 2008, the Primary Reserve Fund ran into A triggering a run on money market mutual funds. Investors pulled nearly $450 

out of prime money market funds (MMFs) in just a few weeks, causing the fun 

stop lending to big banks and industrial giants General Electric and Ford and endangering 

their ability to promptly meet payrolls and other bills. The government responded, quickly 

and creatively, with both a guarantee for existing MMF investors to stop the run, as well as an 

emergency liquidity facility, the Commercial Paper Funding Facility, to provide financing to 

companies that lost their access to short-term funds amid the turmoil. 

In 2014, the Securities and Exchange Commission changed the rules for money market funds 

so this would never happen again. Those rules are working well. But some in the industry 

want Congress to undo them. That would be a mistake. 

Before the crisis, prime MMFs (those permitted to invest in short-term IOUs issued by 

borrowers other than governments) were allowed to promise investors $1 for their shares even 

when the value of their portfolios fell below $1 a share. If values fell to less than $0.995 a 

share, the fund could no longer round up to $1, and a board could close a fund. Unlike banks, 

the money market funds weren't required to hold capital or insurance to back up their $1 

promise-even though they were investing in securities that fluctuated in value. 

This structure created a classic investor run problem similar to the runs that banks faced 

before the creation of deposit insurance in the 1930s. Investors who believe the value of the 

investments will fall to less than $1 have an incentive to pull out their funds before others. 

The first investors to withdraw money will receive $1 per share. Those who wait will get only 

the Oower) market value-often with a delay. As investors run for the exits, funds sell assets 

to meet these redemptions. The sales cascade through the economy, pushing down the price 

7124nOI8, 1:19PM 
54 


71718102.eps

Why Congrw shouldn'l roll back lhe SEC'.s money !llirk<l rulos hnps'ilwww.broo'r.ings.edulbloglup-frool/2018/0I/12iwlly.<on8f,...•hou ... 

2ofS 

of these assets and forcing big companies who borrow from money market funds to scramble 

for funding, making the problem worse. 

In 2010, the SEC tightened the rules to reduce the credit and liquidity risk of the assets that 

prime money market mutual funds could hold. The SEC also required greater disclosure of the 

assets, but the rules cannot eliminate the risk of price fluctuations and thus the incentive for 

investors to be the first out the door. 

So in 2014, the SEC changed the rules, which ultimately took effect in October 2016. Today, 

the value of both prime money market shares and shares of municipal tax-exempt securities 

sold to institutional investors float with the value of the securities in their portfolios. (The 

rules didn't apply to money market funds sold to retail investors.) Funds that invest in U.S. 

Treasury and other sovereign securities were permitted to maintain the fixed $1/share value. 

Since the rules went into effect, short-term markets have been functioning smoothly-and in 

a much less risky environment. Anticipating the change, some money market investors moved 

money from institutional prime funds and tax-exempt funds to funds that invested in less 

risky Treasury and government securities. The total amount of money invested in money 

market funds-nearly$:> trillion-did not change. It just shifted from riskier prime 

investments to more stable government funds that can maintain the $1/sharevalue. 

712412018, I:S9 PM 
55 


71718103.eps

Why Coogrcss sllouldn '1 roll bock the SEC'; moo<y ""11<<1 rules hllp11/\\ww.brool<ing<«<ulblogl•p-fnl<llfl018101112/llily<OIIgrcss·sllou ..• 

JofS 

Money Market Mutual Fund Assets by Type of Fund 

12113/IS IQI31Ml 

Source: Securities and Evchange Commission 

Moreover, the shift has not led to any notable disruptions in short-term funding markets. The 

commercial paper market, an important source of short-term funding for large corporations, 

remains at roughly $1 trillion outstanding, after having shrunk dramatically in the financial 

crisis. Nonfinancial companies have been increasing their commercial paper outstanding, 

despite the drop in prime MMF assets, and are issuing at spreads that have remained quite 

low. 

712412018. 1:59 PM 
56 


71718104.eps

Wloy Congress shouldn ·, roll back lh< SEC's ""'~Y nwi<« rul<s hllp;:IA"'w.brookins><dufblogluf>fronlf201S/Olll:!lwhy«>ngress·shou ... 

Commercial Paper Outstanding 

Source: Federal ReseiVe Board 

4cfS 71'...11201S.I:59PM 
57 


71718105.eps

Why Congr<ss <l10111dn ·,roll bac~ the SEC's money m•r!:et rules hupsJ/Miw.brookings.<dulblog/up-frontllOIS'OI/l:!lwhr<OIIgrCSS·<Iiou ... 

Sofl 

Overnight CP Spreads, Nonfinancial lO day moving average 

0.7 

0.6 

0.5 

0.4 

0.3 

.0.2 

.0.3 

0!112107 03113111 

Source: Federal Reserve Board 

06/13114 01109118 

Most big money managers adjusted to the new rules, but a few- apparently unhappy that the 

changes have cut into their revenues-are pushing Congress to undo them. These managers 

want to allow institutional prime and tax-exempt funds to once again be able to promise to 

redeem shares at $!/share, even when they hold risky assets. Their argument is that these 

funds didn't cause the financial crisis and reforms have gone too far. 

But there is no doubt that the structure of prime MMFs amplified losses and spread the 

problems to many companies when their investors ran. Prime MMFs that promise a fixed $1 

are a source of systemic risk. Post-crisis rules aim not only to prevent a repeat of the last 

crisis, but to reduce the probability and costs of the next one. Reverting to pre-crisis rules 

would risk a return to high levels of private short-tem11iabilities and another destabilizing 

run on money market funds, and threaten stability in the financial system and the economy as 

a whole. 

7/2li201S.I:59 PM 
58 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER 

FROM JEROME H. POWELL 

Q.1. The Federal Housing Finance Agency (FHFA) has proposed a 

new regulatory capital framework for the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (each, an ‘‘enterprise’’). See Proposed Rule, Enterprise Capital 

Requirements (83 Federal Register 33,312) (Jul. 17, 2018). FHFA’s 

proposed rule contemplates that the credit risk transfers (CRT) of 

the enterprises would provide capital relief. Id. at 33,356. According to FHFA, with respect to capital relief for CRT, ’’the proposed 

approach is analogous to the Simplified Supervisory Formula Approach (SSFA) under the banking regulators’ capital rules applicable to banks, savings associations, and their holding companies.’’ 

Id. at 33,358. But FHFA also acknowledges that ‘‘the proposed approach deviates from the SSFA in that it: (i) [p]rovides for a more 

refined view of risk differentiation across transactions by accounting for differences in maturities between the CRT and its underlying whole loans and guarantees, and (ii) docs not discourage CRT 

transactions by elevating aggregate post-transaction risk-based 

capital requirements above risk-based capital requirements on the 

underlying whole loans and guarantees.’’ Id. 

What are the material differences between (i) the rules governing 

the capital relief afforded a CRT of an enterprise under FHFA’s 

proposed rule and (ii) the rules governing the asset credit, liability 

reduction or other capital relief afforded a similar transaction of a 

banking organization under the rules of the Board of Governors of 

the Federal Reserve System (the Board)? 

A.1. The Federal Housing Finance Agency’s (FHFA) proposal on 

‘‘Enterprise Capital Requirements’’ recognizes the risk mitigation 

effects of credit risk transfers (CRTs). CRTs are transfers of credit 

risk from Fannie Mae and Freddie Mac on a portion of their loan 

portfolio to private sector investors. If CRTs meet certain qualifying criteria, Fannie Mae and Freddie Mac are able to reduce the 

amount of capital held against those portfolios. 

The treatment for CRTs proposed by the FHFA is tailored for 

two types of products: single-family home loans and multifamily 

loans. These products have standardized characteristics that are 

incorporated in the FHFA’s proposed approach for risk weighting 

these exposures. 

The regulatory capital rule, adopted by the Federal Reserve 

Board of Governors, the Office of the Comptroller of the Currency, 

and the Federal Deposit Insurance Corporation (collectively, ‘‘banking agencies’’), similarly recognizes credit risk mitigation effects of 

credit risk transfers and allows a banking organization to assign a 

lower risk weight to an exposure. However, relative to the approach proposed by the FHFA, the banking agencies’ capital rule 

recognizes credit risk mitigation for a much broader variety of exposures. 

The banking agencies’ approach for recognizing credit risk transfer through a securitization needs to be flexible enough to accommodate a wide variety of securitized asset classes without standardized characteristics. The approach may require more capital on 

a transaction-wide basis than would be required if the underlying 

assets had not been securitized, in order to account for the comVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00062 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
59 

plexity introduced by the securitization structure. Furthermore, the 

banking agencies’ capital rule requires banking organizations to 

meet certain operational requirements. An inability by a banking 

organization to meet these operational requirements may lead to 

higher risk weighting, relative to the FHFA’s proposed approach. 

Q.2. Does the Board expect to consider FHFA’s approach to capital 

relief for CRT, and also the experience of the enterprises with CRT, 

when the Board next reviews its own rules governing the capital 

relief afforded to banking organizations for CRT and similar transactions? 

A.2. The FHFA’s proposal is specifically designed for Fannie Mae 

and Freddie Mac and their specialized lending purposes. The FHFA 

has calibrated its proposed capital requirements and tailored its 

credit risk mitigation rules to two specific categories of exposures: 

single-family home loan and multifamily loan portfolios. 

Banks have a wider variety of exposures than Fannie Mae and 

Freddie Mac. Thus, banks require a different calibration of capital 

requirements and a more general set of rules governing the recognition of credit risk mitigation. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON 

FROM JEROME H. POWELL 

Q.1. International Organizations. Background: The Federal Reserve 

has membership in several international standard-setting bodies. 

Among them are the Bank for International Settlements (BIS) and 

the Financial Stability Board (FSB). These standard-setting bodies 

provide opportunities to push U.S. interests and greater regulatory 

harmonization globally. The level of participation by the Federal 

Reserve going forward is unclear. The question is intended to give 

Chairman Powell an opportunity to describe his vision for the Federal Reserve’s participation in these international organizations. 

Chairman Powell, the Federal Reserve has traditionally played 

an important and active role in international standard-setting bodies such as the Bank for International Settlements (BIS) and the 

Financial Stability Board (FSB). This has been important for both 

representing the interests of the United States and promoting policies that benefit the global financial system. In the Treasury Department’s first report to the President on financial regulatory reform, it advocated for robust U.S. engagement in international financial regulatory standard-setting bodies as a way to ‘‘promote financial stability, level the playing field for U.S. financial institutions, prevent unnecessary regulatory standard-setting that could 

stifle financial innovation, and assure the competitiveness of U.S. 

companies and markets . . . .’’ The Treasury Department recommended in its report that U.S. regulators advocate for international regulatory standards that are aligned with U.S. interests. 

As Chairman, what will be your top priorities when representing 

the United States in international standard-setting bodies such as 

BIS and FSB? 

A.1. One of our top priorities in international standard setting bodies is to consolidate the financial reform gains we have achieved 

globally. These include a responsible increase in bank capital 

60 

standards, introduction of liquidity standards, recovery and resolution planning for the most globally active and systematically important banks, and mandates to increase incentives for financial firms 

to centrally clear derivatives. As we get further from the financial 

crisis, it will become easier to forget the reasons for which we took 

actions to strengthen significantly the prudential framework for 

banks and global financial stability. Therefore, it is important that 

the United States, with its large number of globally active financial 

firms, continue to play a central role in reenforcing this message 

at the international level. 

At the same time, we believe now is an appropriate time to 

evaluate the reforms to ensure that they are working as efficiently 

and effectively as they can and do not give rise to adverse incentives. The evaluation work, already underway, may lead us to adjust various standards to achieve these objectives while maintaining the strength and resiliency of the system. 

Q.2. Can you describe the work you hope to accomplish or new initiatives you hope to pursue in BIS, FSB and other relevant international standard-setting bodies? 

A.2. One priority is to finalize the bank capital framework for trading activities. Strong standards are necessary for these activities as 

trading activities facilitated many of the riskier bank practices that 

led to the crisis. At the same time, it is important to ensure that 

these standards are well-crafted in order to avoid adverse effects 

on market liquidity. The international standard-setters are also 

working to build up financial firms’ resiliency to operational risks, 

including those emanating from cyber-risks. These risks are some 

of the most important risks that financial firms face today. These 

international efforts are aimed at ensuring that we have common 

terminology to discuss these risks and have a common set of expectations for firms’ resiliency in the face of operational risk incidents. 

Q.3. EU. Background: Legislative bodies in Europe are considering 

draft revisions to the European Market Infrastructure Regulation 

(EMIR) that would bring U.S.-based and other third-country central counterparties (CCPs) under the regulation and supervision of 

the EU for the first time. The proposed changes would expand the 

European Securities and Markets Authority’s (ESMA) and the European System of Central Banks’ supervisory authority over thirdcountry CCPs, including U.S. CCPs, that are recognized to do business in Europe. EMIR’s stated purpose for making these changes 

is to address the potential risks that third-country CCPs could pose 

to the EU’s financial system. These changes could also reopen a 

2016 equivalence agreement for derivatives clearinghouse supervision between the CFTC and the EU authorities. CFTC Chairman 

Giancarlo has expressed significant concerns regarding the potential impact this proposed legislation could have on U.S. CCPs. In 

recent testimony before the U.S. Senate Agriculture Committee, 

Chairman Giancarlo stated that ‘‘regulatory and supervisory deference needs to remain the key principle underpinning cross border 

supervision of CCPs. Deference continues to be the right approach 

to ensure that oversight over these global markets is effective and 

robust without fragmenting markets and trading activity.’’ The 

question is intended to determine how Chairman Powell’s intends 

61 

1See, Federal Reserve Policy on Payment System Risk: https://www.federalreserve.gov/ 

paymentsystems/files/psrlpolicy.pdf. 

to address this issue and whether his views align with that of other 

U.S. regulators. 

The European Union is considering legislation that, for the first 

time, would permit EU regulators, including the European Central 

Banks, to directly supervise systemically important U.S.-based and 

other third-country CCPs, including U.S. CCPs in the securities 

and derivatives markets. This approach itself could pose risks and 

potentially interfere with the Federal Reserve’s ability to ensure its 

policies are being effectuated without interference by EU supervisors. The U.S. Congress and regulators have chosen to not take 

this approach and instead adhere to the long-standing principal of 

regulatory deference. 

How do you plan to address this situation as Chair? 

The proposed legislation (EMIR 2.2) would subject U.S. CCPs to 

overlapping EU regulation and supervision without deferring to 

U.S. regulators that oversee these entities; namely, the Federal Reserve, SEC, and CFTC. Do you share CFTC Chairman Giancarlo’s 

concerns about this proposal? If so, are you coordinated in your position and messaging to the EU? 

A.3. The U.S. central counterparties (CCPs) that may potentially 

fall within the scope of the proposed European Union (EU) legislation to amend the European Market Infrastructure Regulation include those designated as systemically important financial market 

utilities (DFMUs) by the Financial Stability Oversight Council 

under Title VIII of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank Act). The Commodity Futures 

Trading Commission and the Securities and Exchange Commission 

are the supervisory agencies with primary responsibility for supervising and regulating these firms. The Federal Reserve Board 

(Board) plays a secondary role in the oversight of these CCPs 

under Title VIII of the Dodd–Frank Act. The proposed EU legislation has more direct implications for the primary supervisors of 

these firms, and those agencies are actively involved in a dialogue 

with EU authorities. To date, Board staff has worked to educate 

EU authorities on the legal framework created by Title VIII, explained the nature of the Board’s role in the oversight of DFMUs, 

pointed out differences considered in the proposed EU legislation, 

and expressed support for cooperation among authorities. 

The Board has a long-standing policy objective to foster the safety and efficiency of payment, clearing, and settlement systems and 

to promote financial stability, more broadly. 1 In that policy, the 

Board has set out its views, and related standards, regarding the 

management of risks that financial market infrastructures, including CCPs, present to the financial system and the Federal Reserve 

Banks. It has also described how it will engage cooperatively with 

authorities with direct responsibility for particular CCPs located 

outside of the United States. 

As a central bank, the Federal Reserve has a particular interest 

in liquidity issues. As far as liquidity risks are concerned, it is immaterial whether a CCP is based in the United States or abroad 

so long as it clears U.S. dollar denominated assets and makes and 

62 

receives U.S. dollar payments. The current EU legislative proposal 

outlines that the European Commission, in consultation with the 

European Securities and Markets Authority and the relevant EU 

member central bank, may determine a third country CCP to be of 

such systemic importance to the EU that the only way to mitigate 

the risks posed would be for that CCP to establish its clearing business within the EU. This aspect of the proposed legislation presents a risk of splintering central clearing by currency area, which 

could fragment liquidity and reduce netting opportunities. Given 

the extensive cross-border nature of the firms potentially covered 

by the proposed EU legislation, we support the EU and U.S. authorities’ efforts to search for cooperative solutions to these issues 

that promote CCP resilience while upholding the aims of both U.S. 

and international authorities. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS 

FROM JEROME H. POWELL 

Q.1. Supervising large, globally active banking organizations—such 

as those covered by the Federal Reserve’s Large Institution Supervision Coordinating Committee (LISCC)—are among your agency’s 

most important responsibilities. While LISCC supervision traditionally relates to areas such as lending, credit risk, and capital 

and liquidity risk, many of the strategic and operational risks that 

larger banks manage are in areas unrelated to traditional banking 

services and functions. 

My concern is that as these areas become a larger potential 

source of risk, supervisory teams may not have the technical expertise to properly oversee these complex financial institutions and 

may in fact be tempted to substitute their judgement rather than 

apply bright line regulations. In fact, if regulators without technical expertise begin to substitute their judgement for that of bank 

management in these areas, this could lead to increased systemic 

risk. 

How do you make certain that your field supervisory teams possess the requisite amount of technical experience in areas like cybersecurity, technology, incentive compensation planning, and 

human resources management to oversee banks in the LISSC portfolio? 

Do you agree that supervisory staff should not substitute their 

judgment on such matters of general corporate strategy, especially 

when they do not have the requisite technical expertise? 

A.1. As you note, supervising Large Institution Supervision Coordinating Committee (LISCC) firms is one of the most important responsibilities of the Federal Reserve. The purpose of this supervision is to ensure that these firms operate in a safe-and-sound 

manner, consistent with U.S. financial stability. The Federal Reserve conducts supervision of LISCC firms by assessing the adequacy of firms’ capital and liquidity positions, effectiveness of resolution and recovery planning, the strength of risk management, 

governance and controls, and compliance with laws and regulations, including those related to consumer protection. All areas of 

supervision—including quantitative assessments—require some 

amount of judgment. Supervisors undergo extensive training to enVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00066 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
63 

1Other technical areas include, for example, trading and counterparty credit risk management, stress testing, and credit underwriting, and risk management monitoring models. 

sure that this judgment is exercised in a fair and consistent manner that furthers the safety and soundness of the supervised firms. 

While the Federal Reserve has significant experience in evaluating lending, credit risk, and capital and liquidity risk, it also has 

a depth of experience in evaluating strategic and operational risks. 

We assess these risks by considering the effectiveness of boards of 

directors, senior management oversight, reporting quality, independent risk management, and internal audits, among others. As 

needed, the Federal Reserve develops or hires personnel with the 

necessary expertise. 

In all technical areas, the Federal Reserve uses both quantitative 

and qualitative analysis to assess the strength of firms’ practices. 1

We also use cross-firm comparative analysis, commonly referred to 

as horizontal analysis, to ensure that our assessments reflect the 

range of practices that constitute safety and soundness standards; 

furthermore, this tool allows for a more consistent application of 

supervisory standards. 

To ensure the appropriateness of supervisory findings, material 

supervisory judgments and assessments of LISCC firms are subject 

to a rigorous internal governance process, which includes oversight 

by committees of individuals from different parts of the Federal Reserve System. This process is designed to bring the collective expertise and perspective of the Federal Reserve to bear on assessments 

of LISCC firms. 

A key objective of LISCC supervision, and in fact, supervision for 

all firms, is to ensure that a firm’s governance, risk management 

activities, and internal controls adequately support the firm’s current risk taking and strategic objectives. To this end, the Federal 

Reserve has well-defined and controlled processes that are appropriate for technical and specialized activities. 

Q.2. For several years, banking organizations that provide services 

such as safekeeping and custody to asset managers, have engaged 

with the Federal Reserve on the critical need to refine exposure 

measurement calculations for use in capital rules and credit exposure limits. These discussions have led to the inclusion of technical 

changes to these capital rules in the finalization of the Basel Committee’s postcrisis capital reforms agreed to by the Federal Reserve 

in December 2017. 

One of the most important portions of this agreement relates to 

securities lending which provides a critical source of revenue to 

pension funds, mutual funds, endowments, and other institutional 

investors. Given the importance of securities lending to these asset 

managers which include pension funds, such as the South Dakota 

Retirement System, enacting these technical changes to the capital 

rules for securities financing transactions is an urgent matter. I 

hope the Federal Reserve will consider separating these targeted, 

technical changes from the rest of the Basel IV package and begin 

domestic implementation. 

Is there an opportunity for the Federal Reserve to propose rules 

to implement these technical changes, and perhaps others, separately and ahead of its longer range plan to solicit public input on 

64 

the broader and more substantive capital changes later this year 

through the Advanced Notice of Proposed Rulemaking (ANPR) 

process? 

A.2. The Federal Reserve Board (Board) understands the concerns 

with respect to the capital rules’ treatment of securities financing 

transactions, and Board staff participated with their international 

colleagues on the technical changes provided by the Basel Committee in December 2017. These changes would provide a more 

risk-sensitive treatment of such products, including to better account for diversification and correlation. Board staff, in coordination with the other Federal banking agencies, are evaluating this 

new standard as well as other standards adopted by the Basel 

Committee at the end of 2017 to determine whether and how best 

to incorporate them into the capital rules. 

In addition, the Board has been tailoring its regulations regarding the treatment of securities lending and, more generally, securities financing transactions. On June 14, 2018, the Board finalized 

the Single-Counterparty Credit Limits rule. The final rule applies 

to the largest banking firms, placing limits on a firm’s credit exposures to a single counterparty. These limits address the risks to the 

economy that are created when large firms are highly interconnected. 

During the public comment period, commenters argued that the 

measurement methodology for exposures resulting from securities 

financing transactions would not create proper incentives for risk 

reduction and would not accurately measure the actual exposures 

associated with securities lending activities. In order to address 

this concern, the final rule allows a firm to use any methodology 

that it is authorized to use under the Board’s risk-based capital 

rules to measure exposure resulting from securities financing 

transactions. This approach is consistent with other Board regulations, including the capital rules. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR SCOTT 

FROM JEROME H. POWELL 

Q.1. I appreciate your timely response to my written questions 

from your March 1, 2018, appearance for this Committee. In your 

reply, you wrote that ‘‘the State-based system of insurance regulation provides an invaluable service in protecting policyholders.’’ I 

could not agree more—and believe that the U.S. system of insurance regulation is the best in the world. 

That is why I’m concerned that recent International Association 

of Insurance Supervisors (IAIS) negotiations on the International 

Capital Standard (ICS) in Kula Lumpur (KL) suggest an embrace 

of a European-centric approach to insurance capital standards. For 

example, in the KL agreement, it was decided that the reference 

ICS shall have European-like capital requirements (Prescribed 

Capital Requirement) and use a European accounting method 

(Market Adjusted Valuation). 

In the past, the Federal Reserve has stated that the IAIS does 

not have any authority to impose enforceable obligations on U.S. 

insurance firms and that there is no way that IAIS negotiations 

could result in the application of a capital standard on U.S. insurVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00068 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
65 

1See Advance Notice of Proposed Rulemaking, Capital Requirements for Supervised Institutions Significantly Engaged in Insurance Activities, 81 Federal Register 38631, 38637 (June 14 

2016). 

ance firms that is inconsistent with U.S. laws and regulations. 

However, if U.S. negotiators agree to a standard at the IAIS that 

does not formally recognize the U.S. insurance regulatory system 

or, worse, requires that the U.S. change its regulatory system to 

match the agreed upon standard and we do not change our laws, 

then the EU or other jurisdictions could penalize U.S. firms operating in said jurisdictions. 

Please answer the following with specificity: What positions will 

you take during upcoming IAIS negotiations on the ICS to ensure 

the protection of the U.S. system of insurance regulation? 

A.1. I agree that, in order for an Insurance Capital Standard (ICS) 

being developed through the International Association of Insurance 

Supervisors (IAIS) to be implementable, it cannot be unsuited or 

inappropriate for the United States, which remains the world’s 

largest insurance market. As such, an overly European-centric ICS 

would face challenges to being readily implementable in the United 

States. As the Federal Reserve Board (Board) has suggested in relation to insurance firms supervised by the Board, such a framework may not adequately account for U.S. Generally Accepted Accounting Principles (GAAP), may introduce excessive volatility, and 

may involve excessive reliance on supervised firms’ internal models. 1 Indeed, the Board strongly supports the U.S. State-based insurance supervisory system, which has proven its strength and resilience for well over a century. 

Among other things, this motivates our advocacy of an aggregation alternative, and the use of the GAAP-plus valuation method, 

in the ICS. We continue to advocate, and contribute to developing, 

the GAAP-plus valuation method for inclusion in the ICS. In addition, we support the collection of information through the monitoring period on an aggregation-based approach. 

We also participate along with the other U.S. members, together 

with other jurisdictions including Canada, Hong Kong, and South 

Africa, in the development of such an approach through the IAIS. 

Furthermore, the Federal Reserve continues to develop the Building Block Approach, an aggregation-based approach that, together 

with the Group Capital Calculation of the National Association of 

Insurance Commissioners (NAIC), can be used to advocate the aggregation method. Through field testing and monitoring, we will 

advocate that an aggregation method provides comparable outcomes in supervisory actions and insurance company results relative to the standard calculation method for ICS that is emerging 

from the IAIS. 

As a member of the IAIS, the Federal Reserve, in partnership 

with the NAIC and Federal Insurance Office, remains committed to 

pursuing an engaged dialogue to achieve outcomes that are appropriate for the United States. As a general proposition, we believe 

in the utility of having effective global standards for regulation and 

supervision of internationally active financial firms. When implemented consistently across global jurisdictions, such standards help 

provide a level playing field for global financial institutions. Further, consistent global regulatory standards can help limit reguVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00069 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
66 

latory arbitrage and jurisdiction shopping, as well as promote financial stability. While we would refrain from agreeing to any 

international standard that is inappropriate for the United States, 

it is important to recall that the IAIS has no ability to impose requirements on any national jurisdiction, and any standards developed through this forum are not self-executing or binding upon the 

United States unless adopted by the appropriate U.S. lawmakers 

or regulators in accordance with applicable domestic laws and rulemaking procedures. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TILLIS 

FROM JEROME H. POWELL 

Q.1. Chairman Powell, I’d like to turn to S. 2155 implementation. 

Many of us are hoping that you and Vice Chairman Quarles will 

be taking a robust role in crafting the rules to implement the newly 

enacted law. What role are you currently playing in the implementation of S. 2155? 

A.1. The Federal Reserve Board (Board) is working in an expeditious manner to implement the recently enacted Economic Growth, 

Regulatory Relief, and Consumer Protection Act (EGRRCPA). The 

Board has a well-established governance process for implementing 

rulemakings and ensuring that such rulemakings are compliant 

with the law, including statutory deadlines set by Congress. Draft 

rulemakings are carefully reviewed and considered by the Board’s 

Committee on Supervision and Regulation, which is chaired by Vice 

Chairman Quarles. I meet with staff on a regular basis to discuss 

regulatory proposals and provide direction. The Committee’s proposals for amendments to the Board’s regulations are finalized only 

after a vote by the full Board of Governors. 

Q.2. Many of your staff are the same staff that helped write the 

implementing rules for the Dodd–Frank Act. In some sense, the 

new law mandates they revise their own prior work. From experience, I would say that such a mandate will take robust oversight 

on your part and on our part—do you agree? Can you give us some 

insight into how you and Vice Chair Quarles are managing these 

workstreams and orchestrating the workstreams? 

A.2. As I mentioned above, the Board is working in an expeditious 

manner to implement the recently enacted EGRRCPA. The highest 

priority of the Federal Reserve is to implement the laws that we 

have been entrusted to administer and to work to protect and enhance the safety and soundness of financial firms and the financial 

stability of the U.S. financial system. The Board has a well-established governance process for implementing rulemakings and ensuring that such rulemakings are compliant with the law. I meet 

with staff on a regular basis to discuss regulatory proposals and 

provide direction. Of course, Vice Chairman Quarles has a statutory obligation to develop policy recommendations for the Board regarding supervision and regulation of depository institution holding 

companies and other firms we supervise. He is actively involved in 

the development of proposals to implement EGRRCPA from the initial design through finalization. 

67 

I would also note that, in general, Board staff regularly revisits, 

revises, and tailors previously approved rulemakings. Through the 

rule implementation process, the Board receives feedback from affected banking organizations and other interested parties. The 

Board also learns from the experience of the on-the-ground Reserve 

Bank examiners. Because of this continuous dialogue, the Board 

may conclude that aspects of a regulation require amendment or 

streamlining. 

Q.3. One area where I would hope that congressional intent is followed is with respect to the SIFI threshold in Section 401 of the 

bill. My view is that all banks under $250 billion in assets are out 

of the enhanced prudential standards and that those above $250B 

are able to take advantage of the mandated robust tailoring so that 

the larger regional banks are not treated like the money center 

banks and that we are taking business model and risk into account 

when applying enhanced regulations. Is this your view? 

A.3. Section 401 of the EGRRCPA raised the threshold for automatic application of enhanced prudential standards for bank holding companies from $50 billion to $250 billion in total consolidated 

assets. Under this section, the Board has the discretion to apply 

enhanced prudential standards to bank holding companies with 

total consolidated assets between $100 billion and $250 billion, 

based on consideration of various factors, such as capital structure, 

riskiness, complexity, financial activities, size, and any other riskrelated factors that the Board deems appropriate. 

The core reforms put in place after the financial crisis—stronger 

capital and liquidity requirements, stress testing, and resolution 

planning—have made our financial system more resilient. Firms 

with assets of $100 billion or more can present a range of safety 

and soundness and financial stability concerns, depending on their 

risks and systemic profile. These concerns typically increase for 

firms with assets of $250 billion or more. Therefore, the Board has 

tailored, and will work to continue to appropriately tailor, our regulations to the risk profiles of the films subject to those regulations. 

The Board is carefully considering the statutory criteria under 

the EGRRCPA for determining which enhanced prudential standards should continue to apply to firms with $100 billion to $250 billion in total consolidated assets. The Board is also evaluating 

whether any changes to the enhanced prudential standards applicable to bank holding companies with more than $250 billion in 

total consolidated assets are appropriate. 

Board staff have begun working on proposals to amend these aspects of our rules and we look forward to hearing feedback through 

the public notice and comment process in the coming months. 

Q.4. I also expect the agencies to take a look at all of the regula- tions where they used $50 billion as the asset threshold for application, including those outside of DFA Section 165, and raise the 

number accordingly. What are your thoughts? 

A.4. As part of its implementation of EGRRCPA, the Board is considering which of its regulations require changes given the amended applicability thresholds in the Dodd–Frank Wall Street Reform 

and Consumer Protection Act (Dodd–Frank Act), including section 

165, as well as section 11 of the Federal Reserve Act. In addition, 

68 

in light of EGRRCPA’s amendments to section 165 and consistent 

with the Board’s ongoing refinement and evaluation of its supervisory program, the Board is evaluating whether any other changes 

to the prudential standards applicable to large banking organizations are appropriate. The Board’s capital plan rule utilizes a $50 billion asset threshold and was not affected by the changes made to section 165. Per 

the Board’s public statement on July 6, 2018, the Board will not 

take action to require bank holding companies with total consolidated assets greater than or equal to $50 billion but less than $100 

billion to comply with the capital plan rule. 

Q.5. Chairman Powell, the Federal Reserve and the Office of Financial Research have studied systemic risk and have determined 

that banks under $250BB do not pose a systemic risk and Congress 

passed and the President signed S. 2155 to raise the threshold to 

$250BB for the application of enhanced prudential standards. I believe that the FED should expeditiously follow this directive and 

should follow the will of Congress, and not wait 18 months. Will 

you commit to me that you will direct Fed staff to effectuate this 

new threshold and then move on to tailoring above the $250BB 

threshold? 

A.5. As stated above, the core reforms put in place after the financial crisis—stronger capital and liquidity requirements, stress testing, and resolution planning—have made our financial system 

more resilient, and I would not want to see any material weakening of these reforms. The Board has the discretion under the 

EGRRCPA to apply enhanced prudential standards to firms with 

total consolidated assets between $100 billion and $250 billion. 

When doing so, the enacted legislation requires us to consider various factors, such as capital structure, riskiness, complexity, financial activities, size, and any other risk-related factors that the 

Board deems appropriate. 

The Board is carefully considering the statutory criteria under 

the EGRRCPA and is evaluating whether any changes to the enhanced prudential standards applicable to bank holding companies 

with more than $250 billion in total consolidated assets are appropriate. 

Board staff have begun working on proposals to amend these aspects of our rules and we look forward to hearing feedback through 

the public notice and comment process in the coming months. 

Q.6. The relief in S. 2155 is not immediate, and without prompt 

action, the relief will not come until Nov. 24, 2018, 18 months after 

enactment. Do you plan to take action immediately? 

A.6. There are a number of provisions in EGRRCPA that provided 

relief immediately upon enactment. The Board, along with the 

other Federal banking agencies, have taken action to address the 

EGRRCPA changes that took effect immediately. As described in 

the Board’s July 6, 2018, statements, the Board will not take action 

to enforce existing regulatory and reporting requirements in a 

manner inconsistent with EGRRCPA. For example, the Board will 

not take action to require bank holding companies with less than 

$100 billion in total consolidated assets to comply with certain existing regulatory requirements. These requirements include the enVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00072 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
69 

hanced prudential standards in the Board’s Regulation YY, the liquidity coverage ratio requirements in the Board’s Regulation WW, 

and the capital planning requirements in the Board’s Regulation Y. 

The Board’s statement and interagency statements also discuss 

other changes that took effect upon enactment and the interim positions that will be taken until the relevant regulations are amended to conform with EGRRCPA, including the treatment of high volatility commercial real estate exposures and certain municipal securities in the context of liquidity regulations. 

EGRRCPA also raised the threshold for automatic application of 

enhanced prudential standards for bank holding companies from 

$50 billion to $250 billion in total consolidated assets. Under this 

section, the Board has the discretion within 18 months of enactment to apply enhanced prudential standards to bank holding companies with total consolidated assets between $100 billion and $250 

billion based on consideration of various factors. The Board is carefully considering the statutory criteria under the EGRRCPA for determining which enhanced prudential standards should continue to 

apply to firms with $100 billion to $250 billion in total consolidated 

assets. 

In addition, in light of EGRRCPA’s amendments, and consistent 

with the Board’s ongoing refinement and evaluation of its supervisory program, the Board is evaluating whether any changes to 

the enhanced prudential standards applicable to bank holding companies with more than $250 billion in total consolidated assets are 

appropriate. 

Board staff have begun working on proposals to amend these aspects of our rules and we look forward to hearing feedback through 

the public notice and comment process in the coming months. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED 

FROM JEROME H. POWELL 

Q.1. If changes are made to the Community Reinvestment Act that 

lead to financial institutions, including those that have an online 

presence, to take deposits from communities but actually make less 

of an effort to reinvest in these same communities, would you consider that to be a good or bad outcome? 

A.1. I would view revisions to the regulation that cause financial 

institutions to make less of an effort to reinvestment in these communities as an undesirable outcome. In addition, a successful update to the Community Reinvestment Act (CRA) regulations should 

encourage banks to spread their community investment activities 

across the areas they serve and encourage them to seek opportunities in areas that are underserved. 

Currently, a bank’s performance in its major markets is evaluated most closely and weighs most heavily in its CRA rating. This 

emphasis has resulted in what banks and community organizations 

refer to as credit ‘‘hot spots’’ where there is a high density of banks 

relative to investment opportunities. Meanwhile, other areas have 

a difficult time attracting capital because they are not in a bank’s 

major market, if they are served by a bank at all. 

We believe that any new set of regulations should eliminate such 

market distortions and avoid creating new ones. No matter how we 

70 

1https://plus.cq.com/doc/congressionaltranscripts-5358712?4 

define a bank’s assessment area in the future, new regulations 

need to be designed and implemented in a way that encourages 

performance throughout the areas banks serve. 

RESPONSES TO WRITTEN QUESTIONS OF 

SENATOR MENENDEZ FROM JEROME H. POWELL 

Q.1. In response to my question about the joint agency rulemaking 

required by Section 956 of Dodd–Frank, you said, ‘‘We tried—we 

were not able to achieve consensus over a period of many years between the various regulatory agencies that need to sign off on that. 

But that didn’t stop us from acting, you should know. We—particularly, for the largest institutions, we do expect that they will have 

in place compensation plans that—that do not provide incentives 

for excessive risk-taking. And we expect that the board of directors 

will make sure that that’s the case. And so, it’s not something that 

we haven’t done. We’ve, in fact, moved ahead through supervisory 

practice to—to make sure that these things are better than they 

were and they’re substantially better than they were. You see 

much better compensation practices here, focusing mainly on the 

big firms where the problem really was.’’ 1

Your response suggests that the relevant agencies have ceased 

work on this rulemaking. 

Is that correct? 

A.1. After the Federal Reserve Board (Board), Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Securities Exchange Committee, National Credit Union Association, 

and the Federal Housing Finance Agency (the agencies), jointly 

published and requested comment on the revised proposed rule in 

June 2016, the agencies received over one hundred comments. 

These comments raised many important and complicated questions. 

The agencies continue to consider the comments. 

The Federal Reserve believes that supervision of incentive compensation programs at financial institutions can play an important 

role in helping safeguard financial institutions against practices 

that threaten safety and soundness, provide for excessive compensation, or could lead to material financial loss. In particular, supervision can help address incentive compensation practices that 

encourage inappropriate risk-taking, which may have effects on not 

only the institution in question, but also on other institutions or 

the broader economy. 

Additionally, The Federal Reserve continues to work with firms 

to improve incentive compensation practices and promote prudent 

risk-taking at supervised entities. 

Q.2. Please provide a detailed explanation of how the Federal Reserve is either limiting or prohibiting incentive-based compensation 

practices that encourage excessive risk-taking through supervision. 

A.2. The Federal Reserve, along with the other Federal banking 

agencies, issued Guidance on Sound Incentive Compensation Policies (Guidance) in June 2010. The interagency guidance is anchored by three principles: 

71 

2https://www.federalreserve.gov/newsevents/pressreleases/bcreg201000621a.htm 

3https://www.federalreserve.gov/publications/other-reports/incentive-compensation-report201110.htm 

• Balance between risks and results: Incentive compensation arrangements should balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks; 

• Processes and controls that reinforce balance: A banking organization’s risk-management processes and internal controls 

should reinforce and support the development and maintenance of balanced incentive compensation arrangements; and 

• Effective corporate governance: Banking organizations should 

have strong and effective corporate governance to help ensure 

sound incentive compensation practices, including active and 

effective oversight by the board of directors. 

The Guidance explains how banking organizations should develop incentive compensation policies that take into account the 

full range of current and potential risks, and are consistent with 

safe-and-sound practices. Relevant risks would vary based on the 

organization, but could include credit, market, operational, liquidity, interest rate, legal, conduct, and related risks. The Guidance 

also discusses the importance of considering compliance risks (including consumer compliance) when evaluating whether incentive 

compensation arrangements balance risk and rewards. 

Currently, supervisory oversight focuses most intensively on 

large and complex banking organizations, which warrant the most 

intensive supervisory attention because they are significant users 

of incentive compensation arrangements and because flawed approaches at these organizations are more likely to have adverse effects on the broader financial system. 

Q.3. Please provide any guidance issued to regulated institutions 

or materials provided to bank examiners on incentive-based compensation practices. 

A.3. Attached to this response are: 

• Guidance on Sound Incentive Compensation Policies, issued by 

the Federal banking agencies in June 2010; 2 and 

• A Report on the Horizontal Review of Practices at Large Banking Organizations, issued by the Board in October 2011. 3

Q.4. What metrics, thresholds, and standards is the Federal Reserve using to evaluate incentive-based compensation practices? 

A.4. The Federal Reserve’s approach is principles-based, and recognizes that organizations have unique incentive compensation practices that vary depending on the firm’s organizational model and 

operating structure. The supervisory process focuses on assessing 

how firms have integrated their approaches to incentive compensation arrangements with their risk-management and internal control frameworks to better monitor and control the risks these arrangements may create for the organization. Supervision also considers whether appropriate personnel, including risk-management 

personnel, have input into the organization’s processes for designVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00075 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
72 

4For additional information on the Federal Reserve’s horizontal reviews of compensation 

practices, see: ‘‘Incentive Compensation Practices: A Report on the Horizontal Review of Practices at Large Banking Organizations’’, October 2011, available at: https:// 

www.federalreserve.gov/publications/other-reports/incentive-compensation-report-201110.htm. 

ing incentive compensation arrangements and assessing their effectiveness in restraining imprudent risk-taking. 

Q.5. Which institutions are subject to the Federal Reserve’s supervision of incentive-based compensation practices? 

A.5. The Guidance, issued by the Federal banking agencies in June 

2010, applies to global consolidated operations of all U.S.- 

headquartered banking organizations and to the U.S. operations of 

foreign banking organizations with a branch, agency, or commercial 

lending company in the United States that use incentive compensation. Because of the size and complexity of their operations, Federal 

Reserve supervision focuses on large banking organizations, those 

with the most significant use of incentive compensation, and those 

with the most complex operations. 

Q.6. Were those institutions selected for supervision by asset size 

or some other factor? 

A.6. The principles-based Guidance issued by the Federal banking 

agencies in June 2010, applies regardless of size; however, the Federal Reserve focuses supervisory oversight on the largest banking 

organizations, those with the most significant use of incentive compensation, and those with the most complex operations. 

The banking organizations involved in the horizontal reviews 4

were selected based on asset size and complexity of operations. 

Q.7. If there is no rule clearly delineating prohibited practices, how 

are you ensuring consistency across regulated institutions? 

A.7. Supervision of incentive compensation by the Federal Reserve 

is governed by the Guidance, which is integrated into the Bank 

Holding Company Supervision Manual. Federal Reserve understanding of incentive compensation practices was developed 

through the information collected during the horizontal reviews. 

With that understanding, the Federal Reserve has integrated incentive compensation in ongoing supervisory reviews, whether targeted (such as sales incentives or compliance reviews) or within individual lines of business (such as mortgage lending operations, or 

trading). A team at the Board monitors these reviews to encourage 

constituency. 

To foster implementation of improved incentive compensation 

practices, the Federal Reserve initiated multidisciplinary, horizontal reviews of incentive compensation practices at larger banking organizations. The primary goal was to consistently guide firms 

in implementing the interagency guidance. 

73 


71718201.eps

fedoral Register /Vol. 75, No. 122/Friday, june 25, 2010/Noticas 36395 

an exemption under lhB ftoodom or lnfonnation Act (5 U.S.C. 5521bX4Iand (b)ISI). The confidentiality status ~f the 

infonnation submitted will be judged on 

a =·br..:ase bas~. 

Abstract: The infonnatioo oollocted assis~ tho Pedernl Re5a<Ve,the0fficeof 

the Comptroller of the Currency.lhe Federal Dep~it Insurance Corporation, 

and the Offico of Thrifi Supervision in fulfilling their s~tutory rosponsibililios 

as supervison. Each of these fOilll$ is 

used to collect inronnation in COliRI!ItliOll ~~1th applicaliOI\Sand 

notices filed prior to proposed ch:!llges 

in lhe ownership or rnaaagement of banld:1g organizalions. The agencies use 

the itlformalion t-o evalu.alc l.bc 

controlling owners, stnior om~. 30d 

directors of the in$\lred depository institutions subiect to thetr oversight. 4. Repo~ title: Recordkeeping and 

Disclosure Requirements Associated "'ith Regulation It 

~t8~~:, ~::~ ~:!i •• 

Freql1ency: On ocx:asicn. Repo~e1>: Commertial banks and 

savin&s associations. ESfimared onm.rnl reporting hours: 

Section 701. disc:losures to customers- 12,500 hours; Se<tion 701, d~losllrnS 

to brokers--375 hours; Section 723, 

rocordbepillg---188 hours; Se<tion 741, 

disclosures to custome~l~OO hou.,, Bstimoted tJveropt houn per ~ponsc: 

SecHon 701. disclosures to customersS minutes; Section 701, disclosures to b:okers-15 minute.<~: Section 723:, 

recordk.,pir>r15 minutes; Se<tion 7<11. distiOSUfC;S to customcrs-5 

minutes. 

Number of lllSpomknts: Section 701, disclosures to customers-1,500; 

Section 701, disclosures to broker:s- 1,500; Se<tion 123, reco<dkeepins---75; 

Section 741, disclosures to customl!fS- 750. 

C.neroJ description of reporl: This 

information collection is required to 

obtain a benefit pursuant to section 3(a)(!)(F) of the Securities Exchange Act (15 U.S.C. 7&:(a)(4)(F)) and may be 

gi\•en oonfidenti.'!l treatment tmderthe 

authority of the Freedom of luforrnation 

Act 15 U.S.C. 552(b)l4) and lbXal). 

Abslroct: Regulation R implements certain exceptions for banks from the 

definition ofbroket underSedion 3(a](41 of tho Securities El<change Act of 

1934, as amended by the Cramm· Leach· Bliley Act. Sections 701, 113,and 141 ofRegulario11 R contain information 

collection requiremenls. Section 701 

reqllire.s banks thai wish to utilize the e>:emption in th3t section to maku 

ceciain disdascres to lhe high nel worth customer or institution31 Cllstomer.ln 

addition, section 701 roquircs lllnks !hal 

wish to utiliU!the exe-mption in that sectton to provide a notite to irs broker· 

dealer panner regarding nam,. and other ide11tifying information about 

bank emplor..s. Section 723 roquires a bank that chooses to rely on the exemption in that section to exclude 

certain trust or fiduciary accounts in determining its: compli,anoo with the r.hicfly componsaled tcsl in section 72.1 

to maintain certain records relating tn 

the excluded atwunts. Secl.ifln 7-41 

requires a bank relying on the c.~emption pro\'ided b)• ~1at section to 

provide customers ~>ith a prospedus for 

the money market 1\md securities, not later than the time the cuSiomer 

outhoril,.lhe bank lo effect the transaction in such securities, if the class of S<~ries of seoorilic:s are no! noload. 

lloord ofC9•m~oriM fo<lm!KIW!'~ 

Sytltm. )U:18 2'2, 20tG. 

Jenn.ifer).Johnsl)n. 

s..rtMryoftheS..rd. 

IFR Doe. 201o-1~!)2f'UII!Id 6-2Hit t.4~ol 

flllU't3CO()(UID-01...P 

from lhc National tnrorm~tion Center web.~:;ito at 11'1.-.w.lfiec.govlnic/. Unless othcl'\vi.sc noted. commetlls 

regarding each olthese applications must be recei•ed at the Reserve Bank 

indicated o: the offices of the Board of Governors notlatetthan July 22,2010. A. fed<ral Resme Bank of AOanta (Clifford Sl>nlord, Vice President] 1000 

Peachtree Strett, N.R, Atlanta, Coorgia 

30309: 

r. USAmeriBollC<ltp, Inc .. Largo. Florida; to "'.JUire at least SO pertent of 

the votiogsbares of Aliantl'inancial 

ColJlornlion, and thereby indirectly 

acquire voting shares of Aliant Ban.k, both cf Alexander City, Alabama. B. Fedora! Rosme Bank of 

Minneapolis ljacquelineC. King. 

Communi\)' Affai" Officer) 90 Hennepin Avenue, Minnt:apolls, 

Minnesota 55480-0291: 

1. Fim Holding D>mpcny of Pnrk 

Rirer, llfC., Park River, North Dakota; to 

establish a 1vbolly owned subsidiary. 

Sbeytnne Bancorp.loc., Park Rh·er, 

i\orth Dakota, and thereby acqu.ire 100 

pen;ent of the 1·oting shares of First 

----------- Sharon Holding Company, Inc .. Ane!a, 

fEOERAL RESERVE SYSTEM 

Formations of, Acquisitions by, and 

Mergers ot Bank Holding Companies 

Tho companies listed in this notice have applied to the Board for appmval, pursuant to !be Bank Holding Company 

Act ofm6 (12 u.s.c. !841 tt stq.) 

(BHC Act), Regulalion Y Ill CFR Pan 225), and all other applicable statu:.. and regulations Ill become a bank 

holding company and/or to acquire the 

assets Oi the ownenllip of, control of, or 

the power to vote shares of a bank or 

bank holding company and all ofthe banks and nonbanking companios 01vned by the bank holding company, 

includir:g thecompanios li~ed belo". 

TI>e applications listed below, as well 

as olhor related filings roquirod by the Beard, are a\·,ailable for immediate inspection at the Federal Reserve Bank 

iDdicated. The applications also 11'itl he 

a.vailabls for inspection at the offices of the Board uf Cul'etnors. Interested 

persGns ma~· express their views in writing on the standards enummtcd in tho BHC Act (12 U.S.C. 1842(c)).lfthe 

proposal also involves the acquisition or a nonbanking CQinpany, the rc\•icw also 

includes whether the OC<JU~ition of tho non banking company complies with the 

Slandards: in sed ion 4 of the BHC Ad 

(1?. U.S.C. 1843). Unlessothorwise noted, non banking activities will be 

conducted throughout the United States. Additional information on e~ll bank 

holding companies may be oblained 

North Dakota, and indirectly acquire 

votingsharos of First State Ba1lk of Sharon, Sharon, Nonh Dakota. In 

connection with this application, 

Sheyenne Bancorp, lnc., has also 

applied to become a bant holding 

com pan}'· 

brd Gf Covetr.Of$ or the redmt RestiVe Systtlll,jt:ne2"2,'l0t0. 

R.obett deV. Frit:tMn, 

0.}1fJtyS<m!aryoftheS..rd. 

DEPARTMENT Of THE TREASURY 

Office of the Comptroller ot the Currency 

(Do<l<et ID O<:C-2010..0013) 

FEDERAL RESERVE SYSTEM 

IDo<!<oiNo.OP-1374) 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

DEPARTMEtiT Of THE TREASURY 

Ollice ol Thrill Supervision 

(Dooi<et 10 OTS-2010..0020] 

Guidance on Sound Incentive 

Compensation Policies 

AGENCY: Office ofthe Comptroller of the Clurency, 'TreasUl)' (OCC): Board of 

Covemors or the Federal Reserve 

Sy•lem, (Board or Pedernl Resarve~ 
74 


71718202.eps

36396 Federnl Register !Vol. 75, No. !22/Friday, )une 25, 2010/Nolicos 

foder.ll Deposit lnsurnnceCorporation It is clear, however, that (FDIC); Office ofThrifi Supervision. compensation arnngemenls can provide 

'lmsury (OTS). executi•os and employees IYith ACTIOlt FinaJ guidance. ir.ccnli\'C:S lo lake impmdcnl risks tht are nol consistent with the long·tenn SUW!AIIY: The OCC. Board, f'DIC and heahh of the organiution. for example, OTS (collecti"ely.tho Agencies) are offering large payments to manager> or 

adopting final guidance drsigned lo employees to produr,e ~iU!bfc inaeases 

h(llp ensure tbal incellli~·e in short-term revenue or profit-without 

compensation policies 2l banking regard for the potentially suOOI>ntial 

orgauiutions do not encourage short or lttng-term risks associated wllh imprudent risk-taking and areco1tsistent that nwenue nr profil~n encourage 

~<ith the safety and soundness of the managers oremploy.,. to toke risks that organi«~tion. are beyond the capability ofthe 

OATES: Effective Dote: 11m guida.llc:e is financial institution to Jnan3gc and 

effecth•e on Jun~ 25, 2010. control. FOR RJRTHER INFORJIATlON CONTACT: flaw00 ince11tive compensatiOJl 

OCC: Ka«!n M_ KwHosz, Oim;:h>r, practices in tho financial industry wm one of many factors ct~ntributing lo the Operntiolllll Risk Policy.(202) 81~- fin•ncial crisis that began in 2007. 

9~57, or Reggy Robinson, Policy a.n~ing organiutions too often Analyst, Operntiolllll Risk Policy, (202) rewarded employees lor increasing tho 

67l-i!36- o~ganiution's rsvenuc orsllort.tenn Board: William F. Treacy, Advi,.r. profit without adequate recognition of (202) 452-3859. Divi~on of Banking the ris!<.s tho employees' actiYitios posed 

Supervision and Regulation; Marl: S- to the organiution. 

Carey. Advi,.r, (202) 452-2781, H"ing wito\e.<sed the damaging Division o(fntematiorutl Finance; consequences tbat can result from 

K1eran J. Fallon, Associa1e Gellernl misaligned mamli\IBS, many financial Counsel. (202) 452-5270 or Mich.acl W. institutions are now te..c:Q.rrnnmg the1r 

Waldron, _Cotl"'?l, (202) m -2 798, compcr.sation structures with the goal 

Legal DJ\' o~. F ?r users ~r t~rbeuer aligning the intere.~ls or Teleoommumcattons Oe\•tee for the Deaf managers and other e1nployees with the 

MllD'J only, contact (2~2) 2ii:H869. long-term health of the institution. 

FDIC: Mondy Wast, Ch•.•C Pohcy and hlignillg tho inll>rests of shareholders Prosram Development, Dw•s1Gn of and employees however, is not always 

Supervision and Consumer Proteclion, sufficient to p~tect th8 safely and 

(202) 898-722t,or Rc~rt W. Walsh, soundness of a banking organi«~tion. 

Revoew i!ltamm<:'·.P~hcy and Pr~m Because banking organiutions benefit Development, Oo,soon of Supen-~oon dinlctly or indirectly &om the 

and Consumer Prot octo on, (202)898- prote<tions offered by the Red oral safety 

6649. , . . net (including the ability of insured OTS:Rit~ Gaffin, fman:oaJ Analyst, depository institution.< to,..;,. inS\ored RIS~ Mod~hng and Analysos, (202) 006- deposits and access tloe fed em I 6181, or R1chard Brulnett. Semor Reserve's discount window and 

Con!pli~ce Cou?sel, Regulations and payment servictS), shareholder$ of a Leg.slatton Dnli.sJon, (20219?6-7 <a09; banking organization in $0me cases may 

Donna Deale, Oorector,Holdmg_ be willing to tolerate a degru of risk Company and International Pohcy, (202) that is incons~tent with the 

906-7488. G_roYOtto G3rdineer, orgonitation's safety and sou.ndness. Managmg Dtrector, Corporata and Thus, a reYiew or incentive 

ln!""'tionaiA<:Ii•ili", (202) 906-00611; compensation amonge.:nents and related 

Office o~Thnft SupcmSIOn,l700 C corporate govemance practicts: to 

Street, NW .. Washmgton,OC 20>52. ensure that they aro efre<ti" from the 

SUPPLEMEnURY ~RMAl O~: Sll!ndpcint of shareholders is not 

I. Background 

Compensation a.'T3ogcmc.nts arc critical tool~ in lhe.sucee.,~ful 

management of financial institutions. These amngemenL~ serve several 

important and worthy objecti•·,.. including attracting skilled staff, 

promoting better organiz.ation-wLde and 

employee performance, promoting 

employee retention, providing retiremer.t secttrily to employees, and 

low ~1gan mganiz.alion's pC'I'S{)nnel 

oosiS to Vlry along with re'"nuss. 

sufficient to ensure they adequately 

protect the 53fety >nd .~<~undness of the 

organization. 

A. Proposed Gtridonce 

In Octobor 2009, tho Fedond Reserve issuod and requcslcd oommcnt on 

Proposed Cuida«:e on Sound lncenti" Compon.<ation Policies ("propo..d 

guidane<")lo help protect thesaroty and 

soundness of banking O<ganitations 

supervi"'d by the Federnl Reserve and to promote the prompt impro\'cmcnt of 

ittten~vew:n~n,<al on practices 

thro~out tho banking indusky.' The 

proposed guidance'"' based on lh,.. 

key principles. TI1ese principles 

provided that incentive compensation 

arrangements 31 <lt ba11~ing organiution 

should-

• Provide employm incentives (hat 

appropriately balance risk and reward; • Be compatible with p,ffectivc. 

controls and risk-n1anagement; and • Be .<upported by •trong r.orpornle governance, including actiV"e and effective ovmight by the organization's 

board of directors. Because incentive compensation 

arn11gements for exet:uth·e and nonexecuti•·e employees may pose safety and souodness cis!<.! if not properly 

SW<tured, the proposed guidance 

applied tos~::•,iotexecul ves as well as other employees who. cithe.c iodi,idually or as part of a group,~~" 

the ability 10 exp~ the relev~>t 

:~~~ 1~~i~tion to matori.1l 

With respect to the first prinoiple, the proposed guidanco, among other things. 

pro•ided that a banl:ing organiution should ensurs that its incentive 

comptnsalion arrangtlmf!nts do not encourage ~horl-le:rm profits at the expense of s.hort· and longM-term risks 

to the organi«~tion. Rather, the proposed guidance indicated that banl:ing 0'8'11iL1tions should adjust the 

incenti~·eoompe•,salion pro\lided so that eonployees bear some ol the cisk associated with their activities. To be fully effecti,e, thesa adjustmentssbould 

takoacoountol the full range of risk< 

that the employee.-:' acth1ilies may pose for the organiution. Tho proposed 

guidance highlighted "'""'I methods that banking organizations could use to adjust incentive compensation awards 

or payments to take acoouot of risk. WiL~ respect to the saoond principle, 

the proposed guidance provided that 

banking organ 1~tions should integrate their approaches to incentive 

compensation arrangements witli their risk~management and internal control 

frameworks to better monitOT and control the risks: these. 81't'8Jlgtments 

may create For lhe organization. Accordingly, the proposed guidance 

provided that banking orgoui«~tions 

shuuld ensure that ris~-management 

personnel have an a.ppropriate role in 

dtiSigniug incentive compensation 

arrnngements and as.~ing whether the amngcmcnts may encourage impntdent 

risk·taking.ln add ilion, the proposed 

guidance provided that banking 

organil.ations should track incentive 

oomptm~tion aw·ards and payments. 

risks lakcn.and actual risk outcomes to 
75 


71718203.eps

Federal Register/Val. 75, No. 122/Friday. )uno 25, 2010/Notices 36397 

determine whether incentive 

compensation pa,ments to employoos are reducod oc adju.stod to retlect 

adverse risk outcomes. With respect to the third principle, 

the proposod guidance providod that a ban~ing Olll'nization's OO.rd or directonshould pia)' an informed and 

active ro!e in ensuring that the organiution's oor.tpoosation 

arrangements strike the proper balance bct~vccn risk and profit Mt only at the 

initiation of a compensation progrnm. butoo 8JI ongoing basis. Thus. the 

prop~1ed guidance provided that boards of dired.or::;:should «wiew· and approve 

b:)• elements of their organizali01a1 ina~nH\•e C<lmpe.nsation systems aaoss 

the org,ani23tion, receive and review periodic evaluaUons of whether l11cir 

organizations' compensation systems for all major sogments or the 0'8'nil3tion 

are achieving their risl::-miligaliom 

objecliv<iS, and directly approve tbe 

incentive compensation arrangen•enls for senior executives. 

The Board's proposed guidanc:e 

applied 10 all banking organi-za1ions 

suptrvistd by tho Federal 1\esom. How·eve.r. the proposed guidance also 

included provisions intended to reflect 

the diversity among banking 

org.miutions, both with n>Spec1to the 

scope and complexity of their activities. as ~><II a.s the preval~1ceand soopoor incentive compensation amngtmellts. 

Thl!.l, lor mmplc. the proposed 

guid8Jico provided that the revieiVS, 

policies, pra<edures, and S)"ttms 

implen10nted by a smaller banla~ 

orgat~iz.ation that uses incentive 

compensatkm anangements or• a limited basis would bo substantially less 

extensive, fonnaUzed, and detl!iled than those at a la.oge, complex hankins 

ocgonization 0-CBO)' that.,.. 

incenti\'e compensation arrangements 

extensively.Jn addition, because sound 

inoenti\'e compensatiGn practices are 

important to protect the safety and soundness or all banking <>~&ani,.lions, 

the Federal Reserve announced lhal it 

wa.uld wlX'k with the a.ther Federal 

banking agencies to promote application of the guidance to all banking 

organizations. 

The Board invited comment 011 all 

aspects ol the proposed guidanco. The 

Board abo specifically requested comments on a number or issues. 

inch.tding whetbe:r. 

Jl:l~p."'ppS(d!\l~(lmledbrllleFednl 

~~lbe trmLCIIOifiSUiedu his fs tbt 

l(ft utiHud by ll~e F'edmlftmml , d4r.nlligg 

SIJChoc.g,taiztlio.'K.lbefiul8'1Nill:.c:el:Se'.Sibt 

... o..g.e.n~ .. ~"'""'r..eo~"""" CI'I(((DI)J$St$ tmli~ 111111* b)' tM 00:. 

11l1Cwlfti'S. 

• Thn thloc core princi,,les are appropriate ami suffiticnt to hclp 

ensure that inccntiYc compensation 

amngements do notthroater. the safoty and soundness of banking organizations; 

• There are any m3terialleg,tl, 

regulatocy, or other imptdinlents to th< prompt irnplemenration of inc.:enlh•e 

compensation arrangements and related 

processes that would be oonslsicnt wilh 

thDWprinciplcs; 

• Fonnutaic limits on incenli\'3 

compensation ~~·ould likely promote lhe .. fely and soundness or banking 

O<ganiutions. "'heth<r applied 

gonerall)' or to specific types of t.'l.lployees or banking organizations; 

• Markel forces or practices in tlle broader iina:1cial services industry, such 

.as the usc of•goJdcn pa.rachutc• or "golden hands~ake" am~ng..,cn~ to 

itlain or attract employees, present 

challenges for ban~lng ocganiutions in 

dc"Jclopingand maintaining balanced itl;ertHve compensation arrangements; 

• Ttte proposed guidance ,~ould 

in1pose undue burdens on. ur have unintended consequences for, banking 

Of8aniz.ations, parti<:ularly srnallu) I~ 

complex 0'8anizations, and whether 

the:re are \l"ays such ~ent~J burdens or com•Equene&~ could be addressed in a 

manner r.onsistent with saftty and 

soundne.'l.S; and • There are types of incentive 

contpen.salion pla:1s, such as organization-wide profit sharing plans 

that proYide for di~\ributions in a manner that is not materia.lly linked to 

the performance or specific cmpiGyces or gcoups of ernployoes, I hat could and 

should be cxcmptod from, or lre.ltcd differently under,lhe guidanr.e t«ausc 

they are unlikely to affocttho risk·taking incentives of all, or a significant numbP.r 

or employees. 

B. SupeNisory lniUalivts 

In conneclino wid' the issuance of the 

proposed guidance, tho Federal Rosorvo announced two supervisory ioitialives: 

• A speci>l horiaootal review of 

incentive compensation practices at lCBO's;and 

• A rcYicwoftnccnhvccompcnution 

practicos at other banking Ofganizations as part orthe regular. risk·focused examination process for these 

organizations. 

The horiurntal review was designed to asss..~: The potenlial for thase 

arrangements or practice$ to encourage improde.nt risk-taking: the actions an 

o:ganizatio11 has taken or proposes to take to correct dcficicndcs in its 

incenti\'O oompc:uation practices; and the adequacy of the organization's 

compensation· related ri.•k·management, 

control, and eorporate governance proce<SOS. 

U. 0\·erview of Comments 

The Board rer-.eived 3~ written 

comments on the proposed go ~ance. 

wbic:h """ shao:d and reviewed by all of the Agcnde:s. Comrncnters included 

banking organizaUnn.s,linancial serviC6S 

trade associations, setVi:.e pro\lide:rs to financial organizations, re~resentalives 

or institutional sh.archoldcn,la:bor 

org.aniZC'Itions, and individuals. Most commenters supported the goal of the 

proposed guidance-to ensure that incentiYe compensation amngements do not encourage imprudent or undue: 

risk·taking at banking ocganizations. Corumenters also generally suppo~ed 

the principlos·based approach of the 

proposed guidance. for example, many commenters specifically supported the 

avoidanct or formulaic or one~ill!-fiJs. 

all approaches to inc.enti\'t 

compensatiotl in the proposed guidance. 

These commenters noted financial org::anitations are \'ery di,·crso and 

should ho permitted to adopt incentive compensation measures that fit tbeir noeds, while also being consistet~t with 

sare and sound GJ)Ctations. Scvt!rnl comruenters also asserted that a rom10laic approach would inevitably 

lead to exa88eraled ri>k·taking 

inc:enti\•as in some situations 'l'hile disooureging emplo)'e<iS from taking 

reasonable and appropriate risks in olhezs. One comrneoter also argued that uni ntandcd con~uence.~ would be 

mere likely to rosult from a "riRid rulcmaklnf than from a flexible. 

princip ~d approach. Many conunenters "''uested lbat the 

Board revi"' or clarify the proposed 

guidance in one or more respecl.~. For example, several commenters asserted 

that~" guidance should impose 

specific restticlio1\S on incenti\le 

compensation at bankingorganiloatiGns 

or mandate certain corporate govunance or risk~managen1eot 

practices. One comment or 

recommended a requiremcnl that most compensation ror senior executivas be 

provided in the fonn or variable, 

pcrlormance·l'cstcd equity aiVardslhat ac• dalerred lor at least five yoars, and 

lhat stock option compensation be 

prohibited. Anotheroommentet 

advocated a ban on "gold~• parachute" paymenls. and on bonuses based on 

metrics related to one year or less or perfonna:nce. Othe:r contmenters 

sugsested tbatthe guidance should require banking orgaotzations-to have an 

independent ehairman of the board of diroctnrs, reqt~ire arrnua\ majority \'Oting for all directors, or pro\1idc far 

shareholders 10 haoc o vote (so c~llcd 
76 


71718204.eps

36398 Federal Register/Val. 75, No. 122/Friday, june 25. 2010/Noliccs 

•say-on· pay" voting pro\•i.sions) on the ince ~tiva compensation amngemenls 

for certain employees of banking organizations. Otherwmment615 

requosted that W1ain types of 

compensation plans. such as org>nlzation-wide profit shari113 plans 

or 401(kl plans or plans covered by tlte Employee Retire:nent lnCO!Ite S.CUrity 

Act (29 U.S.C. 1400 et seq.l. be exempted front the scope ol tho guidance bocau.sa they were unlikely to 

provide employees inccnli\'CS to expose their banking organiution to undue 

ri~k. 

Sevaral commentm, however . .did not support the proposed guidance. Some of 

thest commenters felt that the proposed guidance was unneocssary and that the 

principles used ln the proposed 

guidance were nol needed. These 

commentersarsued that the existing 

system ol flnanc~l regulalion and enforcement is sufficient to address tho 

concerns raised in the proposed 

guidance. Several comnte:nters also 

thought that the proposed guidanco was too vogue to be helpful, and that tho 

ambiguity of tl10 proposed guidance would make compliance more difficult. 

leading to increased cosband regulatory unceruinty. Som• 

comoenlers alsn argued tbat the guidance was not wamnted beca'USe there is insufficient evidence that 

incentive compensation praclices 

contributed to sa(Cl)' and soundness or financial st3bility problenu, or 

quostioned the authority of the Federal R"""e or the ather Federal bonking asencies to act in Ibis 8rP.a. 

In addilion1 a nun1ber Gf comme:mers 

expressed amcem that the proposed g11ida.nc~ would impose undue burde.1 

on bonking arg>nlMtions. particol>rly 

smaller, less c:o:nplex orsanizations. 

These comment"' believed that inoonti'ole r.ompensation practtces. at 

!imaller han king organizations were 

genorally nnt problematic from a safBty and soundness perspective.> A number of oommcnters sugg.,.ted thatall or 

most smaller banking organizations should be exempt from the guic!allc~ /1 

nwnber of oommenters expressed concoros that the proposed guid:lllce 

would impose un:"Casonablc demands on the boards of direc!ors of banking 

organiutions and t$pecially srnallct 

orgaabation.~. 

Several c:ommentel'$ also e~pre.ssod 

concern tltat the pmp.'>S<ld guidaRCO, il implemented, could impede the abil:ty 

ol banking "ll•nizations to attract or 

lQulht olbr:t.ud,o::t<OCilfhe:lltt•oquesto:l 

~lhep!Of'J(ISI:dCG~~beCilfOICtJd 

dii'f«etll)'t: otJ'Sf!'l~lMIMtstlldylltmustof 

UOrsil:l'. 

retain qltalified .staff and compete wilh 

other linancial services pn)\'tdcts. In 

light of these concerns, some 

common tors suggested that tlte guidance t1xpres:sly allo~\· banking ruganizations 

to enterinlosuch compensalic9 

arrangements as the)' deem necessary 

forrecruitttlt:nt or retention purposes. A 

number of comnu~ ters also encouraged the federal e.~e.rve to ~\-ork \\·ilh other 

dom651ic and foreign supea·irors and 

authorities to promo1e ccmsiste.nt 

standards for incentive compensation 

pracllces at financial inslitulions and a level competitive playing field far 

financial service providers. 

The comments rocein~d on the 

proposed guidance are further diSCil!sed bclOh". 

IU. Final Guidance 

Alter carefully reviewing tile 

oomntents on the proposed guidance, 

the Ageucios h01~ adapted final guidance that retains the same l:.ey 

principle> em!>odied in the proposed 

guidance. ·~th a number oladj stm~•ts 

and clarifications that addross mattcrs rajs.ec:J by lhe commenters. Those 

principles are: (lllnceotivo 

compensation arrangements at a 

bonking organi>atian should provide 

employees incontives that appropriately balance risk and financial resuhs in a 

manner that does not encourage 

mpiGyee..~ to expose their organitation.~ 

to imprudent risk; (2)tltOS<: 

arrangements should be compatible 

with efiecti\'e r.onlrols and riskmanag<menl: and (3) those 

arr-ange:nent.s should be supp<t<ted by strong corpcr1te go\'emanoo. including 

:tctive and effective oversight by the 

organization's board of directors. The 1\gellcies believe that it is important that 

incenth·e oompensalion arrangements at 

banking organizations do not JlrO\:ide 

incenti\'es for employoosto take risks that could jeapardile the safety and ~oundne:s.s oflhc organization. The final 

guidance seeks to address tile safety and 

soundness risks of illcentive 

compensation practices by focusing on the basic problem they can poae from a 

risl:.-managemrmt perspe«iva, that is:, incentive compensaticm amngemenlsif improperly slructured-<an give 

empiGyccs incentives lo take imprudent 

risks. 

TheAsencies bel:evo the principles of 

the final guidance should holp protoct the safety ond S<>undnoss of banking 

organiutia:IS and the stability ol the 

financial system, and that adoplion of the guidance is fully oomistent with the 

Agancies' statulol)' mandat1 to protec! 

the safety and soundn~" of banking organ ?.atlons.~ 

Tho final g~tidance applies to alllho 

OOnking Olganizations su(M)rvistd by the 

Agencies. indudil18 national b3nks, 

State member banl:.s, Sl2te nonmember 

banks. savings associations, U.S. bank _

holding companies, savings and loan 

holding companies, the U.S. aperalian.< 

ol foreign bonks with a branch, agency 

or commercial lending company in tho 

United Slates, and Ed go and ogrooment oorpotations (collectively. t.t.lar1ldng 

organizations'). 

A number of ch.a.ngc:s have been made 

to the proposed guidanco iu response to 

comments. For example. tho final 

guidana inclt~des several provisions 

designed to reduce burden on smaller 

banl:.ing organizations and otller 

banki~-3 orgillii\lUo•l \bill•e nol significant tt~ of inoonti\•e 

compensation. The l!gendes also have mode a number of chongos to clarify the 

scope1 intonl, and terminology of th& 

fiuaf guidance. 

A. Scope of Guidonco 

Compensation practices were oot lho 

sole cause of the financial crisis, bul thty certai;1ly ware a contributing 

<Ouse-a fact rocognized by 98 percent 

of the. responde.nls loa ~llfVey of 

ba:nking01:ganizations engaged in 

wholesale banking activities eon dueled 

in 2009 by the Institute oflntemational 

finance and publicly by a number of 

individual fiuancial institulions.' Moreovcr,thc problems caused by 

improper compensation practices were 

not limited to U.S. financial institutions, 

but \vtre e~·ident at major financial 

insliluUons llo'orldwide, a fact recogntzed hy intamational bodies such 

~~~;ts~~~:;!~"e~~ ttlhcrit)" i• Sl!'dion. s olllte f'oim.l Dtposil lu':lf'lllee{fl)O Ad. Ouid&auis tied eo i&Alify 

pruitc.that lbeAgtoc:fcsbtliettwoddc:or~i111te 

ICti~OI:UL.~p~[(~a.&'Ot lcfmlfyrisk.-

W'~.t~)'}l.OO:U ($1rob.. «otbarpn.c(m 

llntlhoA~l.ldicvt.,.UJidNiub:!Jll:iot 

~~it,ltiMS f.1 e.'ISU illg~\hey OpcaitiR I :Afll 

~swlld-.&:~1Mr.S,f '$SI~l*"r.\oll1d 

Uso rm to OTS"s •~;~ oon tr.lpiO)'Illenl «<~!.lidS 

IZCfRS6J.39. 

l$ot.lt!Ai:lltoofb:oma:.iolulfl'~lnc. 

!201»~ C«nprrtJOfi«l in:I'JmtrifJl Ssrlim.: ,,..,., l'ropu .,j l1w .._.., ... /«CI>Of~ 

lW.W.ii$11:1W.MMcblmil&llMpi/ 

!a,IW.otil'tW•)W!OrvAt:I/CI'IflpdJ.firtPCfN.~~ 

·~-"'"'-,.,._ c.m,. ...... /ol$.pdf-s.. .... CBS.Sbul!lbo!d« Report OllliliS'I WriteOo;vU. 

April1a. 1!103. pp. 41-12 (i&a:in-. inw.ti'l't 

~!feW ol t.rBS ((RJ*L'.llil)fl prKtiON as contr:b.lti:~g~ot:s.ltJIOissaA!f!ttedbJURSduo 

tot:.:pott:r=eiOtbt~me~tmaM.} 

ltalll!blt~ 1:-lr-pih!b'tt.Aibf.e«nni/Siw.r~li'GifJI 

im.~?~kJ J~IIICIIO&f>ll .. 

5/mrAo.'&w/\tpC<! ,4/. 
77 


71718205.eps

Federal. Register/Val. 75, No. 122/Friday, june 25, 2010/Nolices 36399 

as the Financial Stability Board (FSBJ and the Senior Supnrvi~ Croup.«~ 

Because ()Ompensation arrangemllnts 

for executive and non~ec.ulive 

'"'ployecs alike may Jl""' safety and S<lundnoss risks if not proporly 

structured, these principles and the final guidance apply to senior 

executives as well a.s other emplo.yees who. either indi\•iduaUy or as part of a 

group, bave the ability to CXJ""" the bankingocganiutionto material amounts of risk.' These enlployees are refened to a.~ •covered emplo}·ees." in 

the final guidanco.ln response to comments, tbe final guidance clarifies that on cmployoo or group of employees 

has thoobility to exp<><ea bank in$ 

orsani7.ation to material amounts of risk if the eruployee:s· activities are material 

to tho organiz.ttion (lr are matttial to a business line: or operating unit that is 

itself material to the organization. Some commenters sugge5ted that 

certain categories of employeos, .,ch as tellers, bookkeepm. administrative assistants, or cmployoos who proc::cs:s 

but do not originate traosactions, do not expose banking otgauizations to si&nificant levels of risk and therefore 

should 1M! exempted irom e<>verage under tho final guidance. The final guidance, like the proJ"""d guidance, 

indicates th31 the facts and circumstances will d&lerminc which 

jobs: or categories of employees h:n-c the ability to exp<>se the o~ganiutioo to n1aterial risk:s and whiclt jobs or 

cat~ries nf employees rna)' be-0\tiS-ide 

tho soope of the guidance. The fi11al guidanu ~nizes, for exa111ple, that 

tellers, bookkoopm, couriers. and data processing per>OMel would lil:ety not 

expose wgani2ations 10 sigoifia.l:'lt risks. of tho types ruunt to 1M! addressed by 

the guidance. On the other band, 

elllpiOJe<s or groups of employees who 

'Sst.1'ilt.I.IKi.ltSt~litJFONJll(1(0)1 fSF 

P,ir~{tJr&er.d~poen$0fiMI'rrx:fia!Sll7 

.U PDFJ(Ba.ei,Siri!ml.llld: FSJI'. April~a\·llbblt 

ll:ltrlpi/ht"il'l~~aCJJJtjt#Jtd.ot$1 

pcblicorio.'l$/r fl»4'b.pdf; .a1ld Sec.~ s.perrisM 

1$p ~l.ffisi·li!O'IV~lliiA'rOMjJ~I~ 

~&:Vln:Oilnq~(B.N.el.Suit~b~: 

SSC.O:tobcr),i\1!Wlleii.A!tp'J/ 

tm1t ftt'tt)~~~~DJ1/wti.•'Jit».'li.if',JI 

1tJ()'JindJ'11011brr.J. 1bF'Ula.od.IISbbili1y 

t'o:u. W.IJ.:OGaU!fli!llefi~IS:fbllit)Bc»rd 

11 .'1~ 2009. 

~brespon.tetoa~ru~ofooo:~~cnosr<lq'di!Q& 

t.hrifiatio:: cqprdi~iiibcl(.cptoll.holetr~•..,~tw 

~ti\'tf *S idtdiiii.!M$11!duloe. befi.-yt 

SUI6noe$1.1lti t.\al'"~~ ui:C.II:i,-o.indodts.*' 

JJIIfJii•DL "txta.~':iftoiEccts"wllhlnihe 

maniAgo!I .... S.d'$~\l.!,ionO[IlO'R 

21$.2($)1\t tc.d.fccpA:I:clytr.Wto~~~nW.S.. 

-.wiUdolllorn•wit\liot!Mr.-i_,oftbe Sec\ltUICJ.&f!d~(".o:~~ml!iN«<'.srdMoe 

ditclostw.o!exoarllw<xw:1pema<iooll?c:AA 

m.AOl(&){l)). S.l'ings.moci.Mtls sboulo:i also 

ttfertOOT'S'$rolc4."tloutsbys:evir.gs~Kw 

IO!Ktnocalift!oiTK:tts.dir«::.ac#,.andlari~l 

s.\¥~ows. 11~S6H3. 

do not originate buslness or ipprG\'C 

tra11sactionsoould Siill expose a banking 

organi1..ation to material risk in some cil'C'Um.<;lance:s. Therefore, thAgem::ie.<; 

do not believe it would be appropriate 

to provide a blanket exemption from the final guidanco fot any category of co1•ered omploj·cos that would apply to 

all banking organiutions. Afte.rroyiewingthcoomments,lha 

Age-~1cies ha\'eretained lhe principles· 

based framework ofthe proJ"""d 

guidance. The Agencies believe this approa~ i$lhC most effective way tn 

address incenliYe compensation 

practices, given the differences in the 

size and tomplcxity of banking "'l!aniutions oo1·ered by tho guidanoe and the complexity, diversity, and range of use of incentive eompen..10;Uion 

arrangements b.y those org3J'Ii7.3tions. 

For example. acth•ilies and risk.s may 

<arysignit.can~y across ban~ing 

crgani?.ations 2nd o:~cross employees within a parttr.ular banking organization. For this reason. the methods used to achieve appropriately 

risk-sensitive compensation 

anan~ments iikely will differ ar.rGSS and within organizations, and use or a 

singlo, formulaic app...,ch li~ely will provide al !cast some emplO)'OOS \\.lith 

incentives to take imprudent risks. The Agencies, howt\'er, htwe not 

modified the guidance.&< some commenters reques.led, to provide that a banking mganization may enter into incentive compensation amngeruents 

that are incon~i.~tenl wHh lhe principles of safety and soundness whenever the orga:niution believes: that such action is 

needed to retain or attract cmpiO)'OOS. The Agencies rec:<>gniu that while 

incentive compensation serves a number of important goals for banking organizations, including attracting and 

retainingskillod s~ff. these goa~ do n01 override the requirement for bao~ing 

organiutions to have incentive compensation systctm~ that are consistent with safe and sound 

operations and that do not encourage imprudtnt risk·taking. Tite final guidan\.6 proYide.~ banking 

organizations \•;ith considerable flexibility in slructuring their incentive compensation arrangements in ways 

that both pro, Ole safety and soundness and that help achie\1C the arrangemonts' 

other obj"'-i1·es. The Agencies: are mindful, howe\·er, 

that banking organizations operate in both domestic and international competitive environments that include 

financial services pro\liders that aro not subject to prudtntial oversight by tllc 

Agenci" ond. tllus, not subject to the 

finalgu.idanee. The Agencies al"' 

retOgnlu tbll inlcnutional 

coor<iinatinn in this area is important both to promGte competitive balance and to ensure that internationally acti\'e 

banking o~gan >ations are subject to 

consistent requirements. For this reason, the Age.ncies will continue to work t.,ith 

their domestic and international COU(llerpa!U to foster sound 

compensation practices across lhe financial services industry. hnpo.rtantly, tb(l final guidance is consistent with 

both the Principles for Sound Compensation Pru<ticc.~ and the related Implementation Standards adoptt<! by 

thei'SB in 2009.• h number of commentcrs expressed concern about 

the levels of compensation paid to"'"'' employees or bankil'8 ocgani>ations. As 

noted above, several oommentfttS 

r"''ucsted thot tho Board eliminate or limit certain types ofinoentive compensation for employees or banking 

orgGnizatioBS. Other eommenhtrs advocate<! that oenain forms or compensation 1M! required. For ex.unple, 

some cornmentcrs ~d a ban on incentive compensation payments made 

io stock options, while others suppo~t<! 

their mand2tOl)l use. Comments also were received with regard to tbe use of 

olher types of stock-based 

compensation, such as restricterl stock and stock appreciation rights. 

Consislent toJith it:s principles-based. 

approach, the final guid"tco dOC$ n01 

mandate or prohibit the usc of any spoci6c forms of paymcnl for inccnti\!C 

compensation or establisb mandatoty 

compensation lc\lels or caps. Rathcr,the rnrrns and le\'els of inrenlive 

compeosalion varmonl.! at banking 

organizations are expet:ted to renect the principles of the lin.! guidance in a manner :ailored to the busjnes.s, risk 

profile, ond other 3\~ibutes of the 

banking organization.lna~ntive 

tompensation stJUCtllres that offer 

cmplayeas rewards for increasing sh()[(· 

tem1 proGt or revenue, without taking 

into atctJunt risk. may encourage. imprudent risk-taling e\leO if tlley meet 

fannuJaic levels o: include or exdude certain forms of oorupensation. On ll1e 

othe:r hand. in~ntivt~ compensation 

arnrngcmcnts of various fortn.5 and 

l"els may bo properly Slroctured so as not to enr.ourage impruderH risk-taking. ln response to c,;omme.nls, the final 

guidance clarifies in a nun1ber of l'C$pccl$l.be expect alton of the Agencies 

ti10t tllc irnpact oftbo final guidanco on 

4$«, FhuOOd St~lizy f'orv..a. t'SF'P:ttdp&e:$ lor~~,io:'1Pndioe4ID$01C:Ci:e~ 

~Siabi.l :yBe.~{NIO'J].FSBPrinc:iplesb 

Sou.ad O:illlpcu.AIIoe Pnct~ lti!pkMMIIIiou 

StAr ..duds ISS !::IS roFi !!Sasei.Swltzelild: l-'S!I. 

~).Mileh! ttNrp:// 

"'rl1)'fi~s!oSIN)'boc~~ 

,_CMJI!qi<l/. 
78 


71718206.eps

36400 Federal Regist•r/Vol. 7S, No. 122/Frid.ay, June 25, 2010/Notices 

baUI.Qa ....,;..oo.s ,.,;u '"Y 

dcpcndi~ on lht .;,. iDd comp!tlCity 

of tho orpntulion and its le<et of usas• of incentive compensation 

a.rrangeJntnts.ll iJ oxpeded tbat the 

guidance will gene<111ly have Jess impact 

on smallflr banking organitalions. which typi<>~lly on: less complex ••d make less 

use ofincenli,-ecompensa1ion 

amngements tiwllargtr banking 

ClplliUti-. o..,..,.. of tbe sim .. d 

oompltxity oflheiropontions, large 

boAki"' orpnizatioos (U!Os)• $hoald 

have and adhere to •)'Siemalic: and fonNiiud pohdes, procodures and 

proooM ... Th"' are considoted 

important iu cruuring that icccntivo 

con1pensation antnge•nents for all coverod en1ployeos are identified aud 

!11vicwed by appropriate Jcvcls of 

m•uagoment (Including the board of 

directrut whl'ftlppropriala and cnntrol 

units), aod Wilby appropmtcly 

bobaoo NJ:s 111d -ards . n. r.w pid.cce~tllelyJl'Sof 

polities, procodum, and system !hal 

LBOs should ba'" ond ,..int>in, but allot are nor o:petlod olothtr banking 

organizations. II is oxpeWd that, 

porticul.lrly in tho c;o,. o/LBO's, 

adoption of this11rinciplcs·based 

approach will require an iterative 

sup<rvisory proeess to ensure lhotthe 

embed dod noxlbility that allo·.•~ ior 

CU$10mieod amngments for each ba~orpniutionclocsnot 

uodennino ellocti•"C illlplcmentatioo of 

rhopi.W.... 

With rospoct to U.S. oper>lioos of 

fouigo bank$, incentive compensation 

polides, includins management, review. 

and oppro"l "''uiromonts fora foreign ~>nk's U.S. OJl"ration! should be oeordiuattd wilh tho foreign ban~ing 

orsanlzalloo's group-wide policies 

developed In acoerdanco with the rules 

oftht fortiS~' banking OJi'lliution's homo coonllJ suporvi10r. These policies 

and pnQiccs should llo coosistmt "ith 

the foro1p boo!:'• ••-.rail oorpora!& arul ........,..t SINCiultaod its 

&omewort for rbk-managemODt aJid 

intmnal conlrot.. as weii&S with tho 

final guldor.co. 

B. Bo/oncedtnoemil~OIIr.~ 

Arto~nLr 

Tho first principle of the fi11al 

SUid.anco is that i1~centh'e compei'Wition 

arta"i'monts should pmvide employoos 

incenlivos thai appropriately balanco 

rlsl:und n:wards in a manncrlbal does 

not encour1ge imprudent risk-taki~. 

The &mOUIIIS or incentive pa)l flO~\'lllg IO 

ccvtred a:r.ployea shculd lab •«ounl 

olaod adfliSl lor the rid:sand losseo- u wdlupi--=ialed ,.;tJ: 

ecplo)"" activilits. so that employoos do lUll baw inccr>li,.., to lab imprudent rille. Theformulztionofthis 

principia b •li&hdy difl..,nl hom that 

u.lod In tho propostd guidance, "hieh Slll!od lhat 01pni~ations sh<>uld provide 

omployoes lncontil'81 that do not enoou,.go imprudent risk-taking beyond 

the "l:'nitalion'• ability 10 efleclivoly 

identil)'end manl!Pirisk. This change .. .., oudoiO cWify that risk· 

IBO:IIC-t proc:td ..... udCOIIInll 

fl:lldioaslhal Ofdinarily licit risk· llb~ do not obmf& the need IO 

idaltify co•·•ad omployea and 10 

develop inCCDtive cornpen.salioa 

amngcmenuthat properly bal"'co risk· taking incentiva. To be rully effedive, 

balandng~djustn'lents to inttnti~e 

compensation amngc.menls should take 

account of tho Ml range of rub thai employees' acti,·itics may pase for the 

oosaoitation, inclodin$aedi~ Mlr'<el. 

liquidily, Ojlfntional.iogol. corepli._ 

.. drtpulatic:lllrisks. 

A aur>ber oiiXIOl-expzessed tho view that lnaeosed coo:nlb c:oold 

milif>!&at.iolba!...,ia incentive 

comptnsalion amngement.s. Under this view, unh:!hlnetd inoantive 

oompensatlon anangoments could bo 

addreMed oi!hor through the modifl<>~lion of the incentive 

compensatioo em1ng<monts or through 

the application of additional or more 

effec:th~ riU. oonlrols to the busin= 

Tho fioal gu!dwe recognizos that 

~andcllec:tii'OriU.·~· 

aed lnternaiCOIIIJOI fuctions"' aitk:altolhtsofdyand~of 

banking "'ll"'italions. HOI<ever,t!lt 

Agencies believe that poorly designed "' managed lnce11lh·e compensation 

armngcmonts can themsclve:s be a 

sowoc of risk to banli11g organitations at1d undennine tho controls in place. Ur.balanr.:ed inctntivecompen.\ation 

arranaement.c; can plaoa sub$tantial 

Mio on tho riU.·maoa;ec:ent and ictemal oon~ol functions of.,... ~·ell· 

rnsnaco:l OlpDIZIIi""" Furl.,.,_ 

poorly llo.bnc:od bcoctin compoas<tiao 

or. .. ge~~toiS caa enco•r-. employees to take affinr.aw;·e ad.iOILS to weaken the 

01:g3nization'.s risi·managemenl or 

lnt!mal conllol r.mclions. 

Tho 6ul guidano>, lil:e tho PfOIIO<OCI 

auidmco, Ollllines b:r method. that are cuntntly in USI to make oompe~tion 

more scnsili\'o to risk. These are nsk odju.llm<nl of awards; defeml ol 

paytnl!lll: longer perfonnance periods: and reduced se:nsili\'ity to shorHorm 

performance. F~ch method ha.s 

odvlniOSN and disadvantages. For oample. incentive compensation arransements b se.,iOftxeaJti\"CS at 

LBO.< arolibly to bo bett&r balooud if thq lm-oh'l cleflml of. sub<u.'llial pGIIioo ol tile ......U.-es' i ... nliYO 

compensation over a molti·y<Ol period, with payment made in the fonn of stock 

or othw<quity-bast<l iOlltumenls and h'ith lhe number of ir.stnuuenl$ 

11ilimlltcly rccch·cd dcpcndenl on tho 

petformauco nl the organization (or, idt.~lly, the perfom,.nce of the executh·o) during the deferral poriod. 

Dcfoml. ho11·ever, may ool be effecti, .. II> coostoining the i..,.,ti,·es o! 

employees wbo may lm-. the ability to 

lllo Cllplliutic:IIO loolttmt ~these ri>b ""Y not bo ,..li,..j 

durin& • ......,.ble defeml poriod. For this ruson, tho final guidanco 

recognizes that in SOint cases, two or mot11 mathod< may be needed in combination (•.g., risk adjustment of 

awards and defonal of payment) to acbiovc all inoontive tompt~Wtion 

am~~pmenl that properly balances risk 

ond reward. 

f\nll11nn010, the lew motholis ootod 

II> the fmal a•ndance.,. oOiexdusi•t. 

and olhot elfecti" Olelhods or 

variatioos NY cxi5t or be dt\-.lopocl. 

Mllhnd.< for achievina babncod 

cotuptnsollon ar.angemenu at one arg;tniutiou may nol be effed.h·e at 

another OJganizotion. Each orcanization is respo .. lble for ensuring that its incentive compensation arrange1ttents arc consist en! with the safety and 

soundness of the organiulion. Tho 

guidaocaclarifies thatLBOsshould 

acthely 111011ltor Industry, acod""lc. 

and .... latory de>"eloplr:EIIIS !• 

i-'liYO OOIIpwatlon prxb<&< and theory ud bo pRpared 10 inoorpol>ll into tbetir incenth-e compensation 

sy>l•ms now or emaging methods that 

'" liktly 10 improve tho organization'< 

long·term financial \~·ell-being and 

13fcty and soundness. In responso to a question asked in the propo!td guidance, several commentor$ 

"''UOSiod that certain t)"POS of compensation plans be lreltod as beyond tho scopo of tho final guiduco 

boca1111 .... ...., .... belie;-..1 theso 

pbns do oollhraleo the saf.ry aod 

,..nd"noss ofbanbg 01pniuticns. 

Those !nclud4d orgaaluliorl-lvide profit 

•haring pions. 4~1(1:1 plans, defined 

benefit plam. and ERISA plant 
79 


71718207.eps

Federal Rtgisttr/Vol. 75, No. 122/Friday, )W18 25, 2010/J'(otices 36401 

The fi .. t&uid.lllU does 1101 exempt any broad categories of <:omperudion 

plan• bued on their tax structuro. corporate fonn. or &latus~ a retirement or other employ .. benefit plans, 

btcau,. any type of incentive compensation pla.11 may be 

implomantf!d in a wa)' that inaeases 

ri•k Inappropriately. In response to 

thas4 comments, how"'"· the fin at guldanco nlCCIJtDiw that the tcnm 

•incaath'O compensatkln• does DOl 

iaclude .,.llli"" .. IS that an: based *>~ely oo the emploj-'level of 

<:or.lpawatiooaid that do DOl W1r}' 

buodoo ... «IIICII1petf.....,.. lllllrics (o,s.. a 401(1;) plul wuftr l<bich 

the Olplizalioo coolribul<s .... 

l""*'l>iO of an ea~ployee's salary~ fn 

addition, the ft .. l guid.,.. notos that incentive compensation plans that 

provldo for '"a«<s basod ,.lely on 

nV<ttlll "'l!anization-wide performan<:A! ore ltnlikoly to provide o:nployoes. other 

lhiln senior executives and incUYi duals who hR\'C tl1o abilit)' to materially affect 

tho "'ll•nization's overall periomance. with unbalancod risk·tal:ing incenti<es. In m;Jny casu, there were commtnlli 

on both ~des of on issue, with,. ... , wanting less or no guidance and other$ 

~'lllting toush, or ''Ct)' Jpecific 

prohibitions. Por wmple. a num !>er of 

com.-aJgUed thai the use of 

"pldon pmtbutes" and $1Jmlar 

mention and roauitrDOOt pro>i>ioas to ..Wn emp!oyoes $hould bo ~Oiled 

bocawo sucll provUions hm been lbu...t ill tbe post." A laJgu r.lt:llber of commenters, ho\\"t.ver, argued egaiDst a 

per st bon on •uch mangements, S.Uting 

that th~ provisim1s were in some cases 

....,llioleloment< of effective recruiting a11d rtte:nlion pac&.lgos and arc cot 

noc:!Warily a threat to sofety and soundness. One: oommenter slatet:l that 

golden pamhute p&)'l>tnts triggered by 

ch•rl£el in cootrol of a banking 

Olpnh: .• uoo are too sreculati\·t to 

'"COW1i' imprudenl risk-tal:ing by employeos. 

'1111 final &uiduce. like the projlCI!«< 

guldanoo. p:o1ides that banl:ing 

OlpniDtions should cartfclly c:omiclu 

tbo po10nli<l for goldta pa!1Chu:.S and s!IOit.r.....,..,..utoal!octthorisk· 

!U.ing beha'riocolomployees.'lbe final 

picbnc:o.dds Lln&u'&< noting !bat 

amogemenu that pro1ide an employee 't~ith 'sum:nteed payoul upo.n 

deJMrtme hom .an org<!nization rog.,dlw of perfonnan<:A! rnay 

"" ~JP~l«<t:t:lbtpt0t1dtror• on'lpkyos. 

(l)'f)laltJt•kirDtw.in!Lupo.'lclipartU111l"'O' u~iutblorathi:JStinmnt aloltht 

«J"'IUihCWI,IOriiOrirt l.a:pa4d~-..PII)•e:'ll* 

••"-.a&eu:od~)'l:'*lol~t~Y.*t.U 

ll"ili!MI"Pt!IONk:•rW:~.we --allol"'ood-,.,.,._. 

neutnliu tilt effect of any bolancing 

fatu"" lncludod In tho ornngon•ent to help prevent lmpntdent risk·"-king. Orgoniutions should ooraider 

including balancing featur~ch as risk adjustn•ents ordefuml 

requlren~ents-in golden pa .. chutos and similar arra gc1n~nlS to mitigate tho potentlol for the omns•ments to 

encou .. lmprudent risk·tokir.g. Provisions ll)al requirt a departing 

employ eo to !Oifeit defemd inoantive 

co:r.pensotlco p.1yments may also "..wa. tho olfoc:ti-oil u.n.I 

mangmtatlf the departi"' oraployoe is .We to nq;otllll 1 'Joldoo 

wdshab" .,..,.....t with the 

•ployoe's new "'S"'iution." Colden 

hiUtdshako pro<isioos p,...tt special ;,.u .. for banki .. ocsoniwions and 

s.pervisors, some ol •·hich are d;.cussed In tho flnolguldanc:o. bec::ouse 

it ts the oct ion of the employee's new employer-which may no I boa 

reguloted in.<titution-that Clln affoct the 

cunent ernploye(s abllit)• to properly align tho employee's interest with the 

''ll'"i,.tion's long-term h .. lth. The final suidanco •totes that LBO.,hould monitor whothor golden handsluke 

atTall$emcr11< are motoriolly "'tlkening the orpnizalioa'5 eft'CHU IOCIWI.raitl 

the risk-latina iroc:onth-.sol omplo~ 

1be ~will contiaueto wen 

with bonkiJia 01pniza1ioos aad otheos to .b-dop approprbto rnrtllods for 

odduuioc "1 elloct tlut sucll ~ll! my h>'l on the.afoty 

and "'urtdness o!bonkie& oqania:arions. 

C. Ct>mporibiliry Wllh E/f«<ive Ct>ntrol• 

end RisMiono,!tmenr 

The seoond prinelpleoflho final 

guidance statos tlult a ban ki•l8 

organi7Atlon's rlsk-n"n~mont 

protlcwtS und internal controls should reiofo""' ond support doc development 

and maintenance of balanced incenlh•e 

"''"P"""tiOO ""'111""<111S. Banl:.ing organiutions s.hGuld integrate lncenth·• compensation .,..,..u ioto tbeir 

rlsk·r.....,ent and int ... lcootrol fnroeworb 10 IIIIUrt thai baiiD<e IS 

ochit\-od.la poniatt.r. bonking 

Olplllnllons should hm oppropri.lte controls 10.....,. thai poocessos for 

acltlevi"' balulco"' followed. ,.,ppropri"c pc®IUICI,lncludlos risk· 

""""'ment per$0nnol,should II>" input In the desisn and assosMleot of inc:entiw cot:'lpensaliGnamngements. 

r.ompensatlon for risk·m•nagoment and control pertMn•l should bo 1ullicient to 

~'*l~o~kt.-.~llltr:b bll a:~, .. ~.._b-.'fCif•~loflbe 

ii:II IM:.d,~wiUOof~Cin'lidilll*lt'r& 

~~e~WtwuWM\'t'bo.lcdt!ltd"Upo~~ 

~c:reii'Mit'ie .. J'I&o)Wsp.~ 

...,l.p.rd. 

attract aod ret>in •rpropriotefy 

qualified P"'"nne and •uch compen5ati<m should not be bued 

subslanttally on lhe financial 

periormanco of tho b.,;n,.. unit that they review. Rather-, t1teir performance 

silo11td bt baser! prirnarily on the achievement oftho objectives of their functions (e.g"'adtLere.noe tD inte~nal 

controls). 

Banking O!Jiniutions •hould monitor inc;e..,th"etompensation awil'dsl risks token and aet\JOI risk outCOI!les to delenair.t whether ii'I(.Cti\ .. 

<OIIlJl"l"tioo P'fi"'''IS toemplo)- artmlucad to reflect od-risk 

outcnrnes.l_,rjn coaperu.ttioo 

.,..,.,..,...u that uo r..,nd not to 

appropr' .. tely reflect risk .noutd bt 

modi6edasn....,.ry.c:Jr&tniutioos should not only p<ol'ido rewuds when ptrformanco stand>nls are mot<>< 

exceeded, they should ol.o roduco compensation when 11tandards are not mru.. U senior cxocutives or other 

emplorees are paid substantially oil of their potential inctnti\

1

e comperuation ~vhen risk outcomes are matt:riall)' 

"'orse tban expected, ernployees may be enco~ed to take large risks In tho hope olsobstantillly increasing their 

personal compensation, kllowioc that their do~'ll5ide risu mlimitod. Simply 

put, ioceDtin cempe:uzlion 

mangemeou shoold 1101 "'"'". "lleods lwin,tlilsthe6rm Jooo."upor:sation. 

A .ificant number ol "'""""'IS .,.pres>oe~ conc.rt~S about tilt scope of the applicability of tho propooocl 

pidanco to ..,.lltr ban'<lng 

O!Jinizations as well.,tho burd~1 the 

proposed guidance "'Uid irnp0$8 on these 0'113nizatinns. In rt~pon.lll to th.,. oomments. the final guidan<:o has made more explicit the Agencies' view that 

doe monitoring 10othods and proe...., used by a banking organl7~tinn should 

be cor.unensurate with the si~ and complexity of the organization. as well 

as its use of inoenlive COlnpensatloo. 

Thus, for example, a smaller 

otganization th!t u.ses ii\Cinthoe 

compeosallon ooly to a limited exlcllt 

moy End tbt it con appropriatoly 

IDODitor its amnge:r:ents tluou8h 

......t ... ,._t proco$>OS. Tbo fioal~abod.....,..specilic 

aspecu of policies ond procod ures related to controls :md risk-managentent 

that aro•pplicable to LBOsand aro not C'.(pCCI.ed or other b3nktng Ol'S'ftilations. 

D. Strong Ct>rporote cwtflro~ 

The third principleoftho final 

g1.1idance is th~l inCC~nti~·o cnmpcnseUon progr.>m.< at bonking otganiwions should be supponed by strong corporate 

governance. including activo ond 

ef!!dioe o1•arsi!)tt by the otganl~ation'l 
80 


71718208.eps

3640Z Federal Rtgilter/Vol. 75, t<o. 122/Friday, juno 25, 20t0/N01ices 

bomd of di11d<n." Thcboordof diteclors olen "'8"'tUiico is uhinwtly 

rosponsiblt for ensuting tb2t the organization's lnce:"Jtive mrnpensalion 

arrange"'enl.! for all CGVered 

employees-not,.lely ,.nior 

oxoculi\·~re nppropriau:ly bill anced and do n01j0<1perdizelhosafety and 

$0Ut\dncu of the organization. Boords of d1leclori should ncei1'0 cia:. and 

anel)£is fnml ~"""tor other """""dlatansuffiticnt toallo1• tho bomd to WOOS ..... Iller the o1..nll 

closipland~ollhe 

mpniutio.:a's inc:entiYI c:o:npc:!\Sition lm"l:t:mtnU are consistent uilh the 

org:aniz.ation's .safety and soundness. 

n.,. "'vlo~<s and roports should be 

appropriately ""P'd to reflect the sire and complexity of the banking 

O'i'fllutlon's activities and lhe prevaleract and scope or its incentive 

annpenutioo trrall,l~lllts. Tht 

Mlc:lutt, rom position, and """"""'of 

tho lloarcl o( diteciGra siloaM be 

oonsttuclod to penoit effecli;'tcv~ 

ol iacoalive cr>mpwatioo. The baanf of dir«ton slloold, for example, have, or 

"-'''""'*"to, a level of expertist 111d cxporienco in risk·~m~gcme..-1t and 

compensation pracliccs in tht fin.aocia! serviCM !«lOr thai is appropriate for tho 

nature. •oopo,and oomplexity of the Olgl.ni:tll1ion'a ICiivities.u 

Ci¥on thel:ey role of senior exocuthu in man~l8 the o\·er.dl risk· 

tW~activiticsof an etpnizatioJI, the 

boa.-.! ol dirctors slloold din>111v 

appnwo-pon.<a!IOO~U 

U\\'olvtaa,..ior IJIICUii,.., and clcsely 

monltror "'ch poymo.1ts and thfir .sensitivity to risk outcomes. lf th.e 

tompensation amngamenu fot a senior executive include a deferral of payment 

or•clawb;)ck• provision, then tha 

review sl1ould lncludesufficicnt infonnation to determine if L~ 

pro11sloolw been Uiggered and 

execu~ as plWie<l. The boord olso 

sbould IJ'Jil'CI"t and dotuiMIIllll)' 

lllllorial oxcopCioos or adjustmtrns to the ii'M::I:ftlive Q)(D.per.Rtion 

am.,...ol.!eslablishedforSCiliC< txeQitives and should ClrefuHy 

c:onsid. ar.d monitor the effecu ~f any approved exctpHons or adjuslmenls to the arra gllmen ~ 

In feSJ>OT\SU lo oomnumls expressing conoorn nboutthe impa~ of the proposed suidanoo on smaller b..nkiug 

orp.nizadons,l.hc final guidance 

tnOolllo ll .. $1ecwfl-..~~ __ , __ .... 

- ..... ~ ........ u.s. ......_c.:t:MII_. l)efiO'sowra!l C*'pCfl .. ..,., ......... llnlda."C. 

•Srtiw....:~tllliaMMid*ll:5rloOTS'' 

l'lllea~~d~:~~uc~ .. ~·am 

56Ul. 

idtotifi• specifiC aspoclsoldla 

oorponlo ,.......,... provisioas ol tho 

final cuidanco lhalaro applicable to LBO. or other Oli>llizalions that u.. incenli'I'C compen~tion to a 11ignificant 

degr,., and arc not oxpe<ted of other banking organizations. In particular, 

boards of dircciOIS of UlO. and other arsaniutions that usc incentive 

"'"'pensatlon to a signiliant degree should acti,..ty ov,_ the 

de> .. lop....,t aod oponlion of the 

Grf'nlulioa'$ in:;:mtive aaopensatioD 

policies. syskms and nl&led a>Otrol prootSS~S.If sudo aa .,...:,.tion does 

1101 already ha•" a c:ompensatioo cornminee. rnporting to ll:e fuU boord. with primary responsibility for ince.nti\C c:ompenu(ion arrar.gemenls, 

the board should consider establishing one. UlOs, lu po~icular, .hould follow 

• systematic approach, outlined in tbo 

final cuid&m, in de~ elopins 

co~<ptnsation <ys:.,.. that""'' 

balucod lncoati" OOIIlpe:>S>tiorl ........, ..... SmniCOIIIIIIODim~ 

ooocom lh>i the propose<! guicb.""' 

1ppe:artd to create a naw substantive qualificotion for boards of dioo<>« that 

requl,.,. tho boards of all banking 

organizatiOJU to han~: members wlth expertise in compensation and risk· 

ma.,.gomeot Issues. A gmup of 

DOr.lmenten nolod thai s!M:h • requlrem<~U could limit Ill already ,,.n pool ol poople suilab!e to sen·e 011 

lloards ol diloclon of llorilio3 

orpoiutioas aod :llat....U... 

"""'fzotions ""'Y oot bal-......, to. or tllo.-rtos tocompmsa~t,diractm 

meeting th.,. additional requiremenl.!. Somo oommenlors at.. stated that terms .su<:~ as -r;IOHly monitor" and •actively 

O\'enoo" could be read to impose a higher s~ d.lrd on dire<tors for their OYcnlgbt of locentive oo<:~pensation 

woos. On the other hand. one 

COJ'!Imenler noted that "'""''tlaw 

requiros finaDdal expertise on the 

boards ol dillldon .. d ...tit 

commiaccs ol public CCillpor.ies .. d ~dlalspecial:zedrisl:­

......... tcompetoru:iosbe"''•inod on tho boards of oll banking 

o1ganizalions. 

To address concemsraistd by th.,. 

commcntors.tho final guidance clarifies that ri.d:.·m.anJgemo.nl and comptns.ation 

expertise and experience a1 the boord lo>tl may be present oolleelively among the memben of the boord, and 1111y 

COlli from fomaltrailli,. or frn:n exptrieoce ID addmsio& risl:· .....,.,.,t a.'ld compor:>Woa isso<s, 

lodudi,.; u a din:c'.«, or may be 

obtained fror:t 1dvi<:e r""il-.d frccn 

outside COUD$01, oonsultan~. or other 

uperu with expertist in incentive 

compmsallon and risl:-:naugcment 

Fluthcnnoro. !be fiul guic!ance 

""'i"luslhat S.'llaller O'i'flizations 

witllles$ complex ond ext""i''t incentive compensation arrangemenls may not find il necossary or appropriate to roqui111speciolly tailored board 

tJCpel1i.se or 10 retain and useoutsidt~ 

txperts in lhis area. A banki113 organiz.ation's disclosure 

proc~iccs should supputsafund sound 

iactnbv.c:oo~tioa~ts. 

SpoclAcally,a banJcir\scrrprtiuliorl 

....,ld supply an appropriate amount ol inronatllon oonc:saizas ils ir.antin 

oompmsation a:ransunenu and rtlatod Nk·nlanagemen!, control, tnd 

JOVemanoe processes IO shan:holders to allow thern to monitor a1ld, where appropriato, lake actions to reslr.lin the 

potential for such arrangmnents to 

enoou,.go emplo)'OCS to ta!<o iloprudent 

ruts. While some <=mentors supporlod 

lncnwd public clisclosure of tho 

"-tiytcompensallonpoll<tioosof 

bantioa "'8"'izaliorls.a piS IIIIJ!It. 

OJ>rus.d conams that illy requind di.sclos.ui1S of ineonti\'e cornpensation. lnfonnation by ~anti"3 orgar>it1tions be llflored toprotecttheprimyof 

employees and take account of the Impact of such disclosures on the ability 

or Of.88nitatiOI1S IO a.tlract 2nd retain 

talent Several commenters sup~ed 

an allfJl-t of roquirod disclosures 

~ith exi•~ """""""onl.! for public 

canpeoies, ugu"" that addilion&l roquirmtnl.! woul.i add to tlu 

,...~a~ory borde:> on bmnns C~~"ganiution.s. 

The propoood guidance did not 

impose specific disclosure "'!uirements on bantl1J8 organizations. The final guldanc:e m¥kes ou.significant changu &om the proposed guidance with rogard 

to di£tlosures. and st.ltcs that the soope 

and level of infonnation discl....S by t 

bank in& orpoization should 1le tailored to tho ••lure and complex:ty of the 

'"l!'niution""' i:S ioc:or.ti\'0 

compensation a.~ 1\efioal 

pitlaaco notes thfl banking 

organlzalioos should comply with tho 

inctnt.i\'t compensltion disclosure requlremenu of lhe Fedenl secwilies lnw •nd other l011~. as npplicablo. A number of oommenters supported additional goyemancc rcquire1n.ents for ban~ :g orgaJliz.ltions, such as .:say on 

poy" pro1·i>ions roquiringsharel10lder 

appro~·•l of compoesation p!w, 

>eparation of the boord cmirand cl>ief 

..-tircolf~a<positions.INjority 

voti~ !or di-.&DDual clcctions !or all di...,!Dn, and iopm......,l.! to the 

audit function. Some of these comments 

,.,.t cha"8"1n Federal law< beyond th 

jw1!dictinn nltho Agcnci~; oth~ 
81 


71718209.eps

Federal Regisler/Vol. 75, No. 122/Friday, fune 25. 2010/Nolices 36403 

address issu~ucb as .. say on pay" 

111quiron:eo.......,.tare currendy under co..,.idmtiGabythCoa&J= 1be6.,1 

pda""' does nd preempt ar P'tdudo theoe proposal•. and indicates that the 

~cies exp<d Oli'niutions to 

oomply with allopplicable >latutory 

di.!closuro, 'oli"3 and other nqaire.uots. 

E. Continuinr Supurisol)•lnitiolila 

The horizont~l review or incelllivo 

compensation 11racliccs at LBOs i3 well 

underway. While Ibis initiati\•6 is: being 

lod by the Fedalol R...,.._lhe other 

F .... lbanl:i"' ......... par'Jcipati~ in tho work. SuporvUc>ry 

t,.m, bave oollec:ted substantial 

information from LBOs concemi11,11 

e.xisUng incenti\ot compensation 

prlCiices and rewed risl:·~~W~ag~Sntnt 

andmrpontts<>~.....,aceprooesse.s.lo 

additioa. LBOs h.lvt .. bmi:!ed mal)"la 

ol shortcomings ar"pJl'" in uining 

prat1ices relallve to the principles 

contained in the propo5ed guidat\ct, as 

•-elias pb"' lor addressing identified ~..........._Some ocpniulions oltcady 

ba10 illlplco>oated dlooges ID m.tb 

lheirincentivec:ompe:n.sation 

arrangements moro risk sensitive:. lndet!d, many organi:ations aro mc.ognit:og lhat strnng risk-management 

and control S)~:ems are not sufficient to protett the orpDWiion m. Ulaoe 

Nb. ioduding riUs wu.: &om 

unba!a.nctd incentive compen~tion 

arrangements. Othu orga.nizatioJU hav6 

considorably more ,VOfi to do. rucllu 

dt,·eto¢ng procosscs that can 

dfetti.-.ly0001pminc:entin 

.....,....tioopaymttiStorUI:sa..t 

rUt outcomes. The Agancies inre:nd to 

eontinue to regull!rly review ince:ntivo 

compensation arrangements and related 

risk·:nanog<menl, oor.trol. and eo<porelt 

go>......,.,. prattiw of IJlOs a.•d to 

work willlt'-o orp.natioas lltrouaJI the supem...y pnx:es. 1n promptly 

COITOCt any deficiencies that may be inconsistent wlth .safety a11d soundness.u 

~r.scalfr..-.~tlo,...... 

--........ -................... ___ 

~tt:b«h.Wu.lellloastad .. a.ml ,... .... ollh<<IMI .. borba 

I• to ldtrJifr tM (w~ot U.C.~it'O plai~S in p!M 

lbt(obt)1lllon'Cf\'d4Gid th4cbx'..m:ia:. 

pttw'~~~Ool~l\~tablilkf ---,u..u ........... 

__ ""'YNt _._ .. __ 

....... .. bo ..... 

~tlttoN-.aMC!c:aapkdyoflJo,.. 

oq&a~t.4t!oottAI:sl:o.cttJi\'t~ 

ltflltSO-'tlo.'lls.Fo.-d'MMuwllorbanlq 

D~p:~il.lliou.thu.•q*"-•!oaktlluthn~llbe 

'C')' l .. ield. if .. ,.Cqoct~ t'allir.i~k:. vor\:tt 

==::.:::.:= 

._ ............. __ .. 11011i1ot!Msetrf~attopedcd :o,bt 

The Agencies intend to actiYoly """'itor tho a<lioru being laken by 

ballki"* orpaiulions wi:lo ....,...to 

iac:eotiTec:ompe.r.salioDana.,_..nu and willnview and updalolhiJ 

guidanct as appropriate IG inct~rponlte 

best pract[oes th~t emuse.ln addition, in order lo mnnitor and encourase imp.~,..,..,.._ Federal Re.orvoo~tff 

will pR:IIOI8. repon. ia OO!ISUitalioo 

with !he ollie< Fod.nl balll:inz accncics. after the conclusion of ZOHl nn lrends 

and de\'elopmants in compensation practices II banking OJB'lli,.tiOD$. 

tV. OtherM1tten 

lo ac:r:onbnco with lilt hpervcrt 

Redudion Act (PRAJ of 1995 (44 U.S.C. 

3506; 5 CPR Pa~ 1320 Appendix A. I). 

the Agencies have determined that C<llain aspocu olthc final guidanco 

constiluto a cr>ll«<ion of iniMaatloo 

1ht !loud tWI this do!ami!W~ 

under tho authority dt!egated to tho Board by the Office of Managant~ltond 

Bud~(OM8). 

An agency may oot ooodu<l or 

sponsor, and ao OflUiUiion i.s not reo;uited ID respond ID. an ialomation 

allledion u nl.., the inlarmatioo 

collection displays a cumlndy valid 

OMB control number. Aoy changes 10 thallgencias" resulatocy reporting forms thai may be made in the futureiD oollect 

i,..,..tioD t.Uted ID inoeoliv. 

cxuupensarioa • ..,.,..IllS would M 

addnssed in a IOJIII'It Federol Ke,isttr JlMice. 

The final guldanco lndudcs 

prov'.sions that statel"it banking 

••iutlOD$ ILBOsl $hould (ij "" .. policies illld praciedWO$ !hat identify 

and desaibt tho rol<(sl of tho pmonntl and units authoriud to be involved in 

inctntivo comJHHlS3tion arrnngcrncnl$, 

identify tho sou roo of sl3nificant ris).. 

related inputs • ..w.lish appropNit 

oonL-ols p-n~ thoso inP<Is ID http 

er=otboirin..,-;ty.illld id.JotlfYtho 

individual[s)and unittsl whosa 

approval is necessary for tho establishment or modification of 

incenli,·e C031.pt.isation amn;.em~lls.; 

(iii emit illld ruinllill sullicient 

4ocurlmllatioo 10 pamitiD >udit of tbe 

organiutioo'j processes for ina:nti\'t 

compensation lmJl8011'ents: (iii) have 

4ny ruaterilll exceptions or adjuslmcnts to the incentive compe.ns:a:ion 

.,......,enu asbhlishe<l for senior e:«<Uti .... appmtdaacldocumoolell 

by its board cf dire<lon; and 6•1 bve ifs board of direct~ rett:i\·o and review, on an :.nnunl or moro frequent 

basis. on .....,mcnt by manO&Oment of 

tho effectiveness olll>o desi3" ar.d 

..-..nr---- .......... n ............. jilll ..... ... -.. -

opcr.~t on oflhoorg.~:nizalion's inoc11Uvc 

oomponsation •)"'en> in providinarisk· 

taking incontii"IS tbat are ooruUieclt 

,.;th the "'»U'izatiort"s saflly tnd 

soundness. 

The occ. rn:c. and ars have 

obtained emclflncy approval under 5 CFR 1320.13 for ;,.uaru:e of tho 

guidanee and ~ill issue a Federal 

Resister IIOli<o shol11y lo: 60 days cl comment as pa11 of tllc regular PRA 

deannce P""""· During tho regular PRA cle<~,ncc process tho cslimaltd average re.sporw time rnay be ro- e..,lu<tcd. 

111• Bo.-d bas approvtd lha mlledioo ol illfarmmoo under iiS 

d.leg>ted authllrily. J.s dis<ussod arlie< 

in this nO(Ice, on October 27. 2009. tho 

Board published In tl10 Federal Register a notice roqucsling comnu~nt on the 

proposed Cuidanc:o on Sound lac:onti"' 

Co:!tpwal!on l'lllides (7~ FR 55U7l 

The comment p<t...J for tbi$ DOUot expired November 27, 2009. The Board 

receh·ed threo: comments thai 

!pecifically addrosstd paperwork 

botden. Tho conunenun werted that 

the loocrly estimato olthe cost of 

CIOI:lpliance sllould be COII.\idenbly hiiher than tho Board projoc:tod. 

tho fi111l guidance clarifics In a number of re.peclllhe expectation thot ll>e elfoct oltht fiRalguidance on 

banli"8 ocpniutions ~ill vary 

dtpeodinc oo tbe size and -plf<ity of the crpniution and its Jevcl of use ofinc~ntivecornpwuation 

amugemflnl!. Forexampfe. tho final 

guldance m1kes more explicit the ''iew !hat tho monitoring methods tod 

P'"""'"' asod by • balll:ins 

cwganization should be cnttun&mUT1t• 

with tho sltt and oomplexity ol the 

O¥g.tnlza1ion, as \..-ell as its use: of 

incenlhtt c:ompensntion. In addition. tho 

6nalguidznot highlights the typcs al 

policies,pracied ...... S)'$1emS.ad 

specific aspects of oorpcnte JIO'"I'Nn<Z 

ll>at IJlOs should hm and maintain. 

but that an nO( expected ol other 

banking organizations. In rospo0$1lo c:omm"'~ and laking tn~o aa::ount the COQSide:ttiou 

diswl:sod ..... tho Board 1$ i"""""' 

the bunien estimate for implementir.g oc modifYing policies and procodurosto 

monitor incentive compensation. for 

this purpou, cor~ideration ofburdon is limited 1D it..., in the final £uidanco oonstitul~ Ill inl...,..tioo oolloelion 

within the IMOning ol the PRA. 1bt 

Board tstimato:sthatt,502largo 

responden t~ would take. 0 11 :.~·emge, 480 bows (lwo .nonths] to modify pollcl~< 

and procedure.s to monitor inccnlh"C 

"""pwatioa. 1lle Board estimates !hat 

5.058 ,...nrospond"'ts ~-..ld tth. on 

ar~. an hours nwo busine!.< ...... , 
82 


71718210.eps

36404 Federal Re&i<ter/Vol. 75, )lo. 122/Fricby. )uno 25, 2010/Nolices 

to &llahlish or modify policies and 

procedures to monitor incentive 

compensation. The total one-time: 

burden iustill'~ted to be l.125,&l0 

hours. In addition, the Board estimates 

that, on a co;tlnuing basis. respoodents 

WO<tld take. on '""&"· 40 hou,. (one business week) each )'eM to maintain policies and procoduros to monitor 

iuocntive compEmSation arrange:~nenls 

and OS\Imatcs the aunualon-goillf: 

burd .. to ho 261.400 bows. The 10101 

anooal PRA blud<o I« this iolorrnatiorl oollaclioll is wiued 1o be 1.388.000 

'-'-

C...ZGI Dtsaiplit»t of lltpo1l 

Thislnfonrlaliollcollet1ionis 

aulhoriiOd punWIIto: S.Ord-Soctioru 11(a), 11(i), 25, and 2SA oliho Fedenl R!serve Act (12 

U.S.C. 2AS(a). 248(i), 602, and 611J, 

soction sol dlO Bank Holding Company Act (12 U.S.C. 1844), and se<tion 7(c) of 

th• lntti<~ationol B>ltking Act (It U.S.C. 3t05(c)). 

OCC-12 U.S.C. 161. and Scction39 or the fodcllll Deposit insurance .Act (12 

U.S.C.t831p-t). 

FDif~'ioclion 39 of the Federal lloposit lnsunrtce Act (12 U.S.C. 

1831p-1). 

OTS-.Sectlon 39oltlte Federal llopostii.,...._Ad (12 u.s.c. 

1831JH) and Secliom 4, S, and 10 o! 

tllo Home O~<nert Loon Ad (12 U.S.C. 

t463.1464,ond 14671~ 

The Agt<~<ies oxpod lo r..W.· tile policlos and proc:oclures for inCOIItive 

comptl"'t:oo ornng<~~~en!S as part ol lheirsupeiVisary processes. To the 

exlent lhe Agencies ooHect information durin.g an examination or a Mnkil'lg 

organization. confidential treatment 

may be afforded IG the reoorcls under 

OJ<omption 8 ol the r'roedom or lnfonnolion Act (FOIA), 5 U.S.C. 

SS!(bXa). 

llr>crd 

1'>11e of lnfr>rmalion U>lkdion: 

Reccrdkeepin& Provisions Associ>led wilh lb Ctziclaoco oo Sound lacenti>~ 

C..porualion Policies. 

Alftq fotm numllrr. FR 4027. ().\IJ oorJrolnolllli<r: 11011-lo ho 

wiplld. 

F'rrJj~tq: Anr.ually. 

Afftt:ttd Public: Busi...,., e< other for·profi:. 

Respondenls:U.S. honk holding 

componles. State member banks, edge and agroo1nent corporations, and! the 

U.S. opcraUoru of foreign honks "ith a branch, agency, or comntcrdal lending 

conopany subsidiary in the Unitod States. 

&limortd oreroge hours per response: 

lDiplementi'l or modi{yL'18 policics ar.d 

J)rOCOdu..,: large rospor!dents 486 

hounamall rtSpolldtnls 80 hour$. 

Mainten.lnco of polt•ies and procedures: 40houn. 

E~imoled numi!fr of rrspondonl$: 

Lt.rge respondents, t .SOt: Small 

res&;i,,~~~·~~f.l!'nnuol burden: 

1.388.000 hours. As mentioned abovc.thcOCC, FOIC, and 01'S have obtained em"B<ftcy 

approval onder 5 CI'R 1320.13. The OCC and 01'S •w:o<als ,..,.. obtained 

prie< to tho Boon! mlsina Its lrJrdm OSiimateshosodootbtCOIDIIIOIIts 

recti vee!. For this reuon, tlto OCC and OTS are pablillli,.la this IIOii::o tho 

oripul ho:d.n ostiaates. They.,,, ts.uc a federal R<Ji!ler notice ~ortly 

for 60 d>ys or com-las pa:t or tho rq;ul.!r PRA doonnco p.....,, Doring 

the resular PtV. clearance process the 

e.<ti:nated avenge response timc may be , ... valuated ba5ed on enmments 

rii(Oived. The FDIC is publisltiog in this 

notice tho rovlsod burden ostinutos 

dmloped by I he Board ba.sed on the comments receh·ed. The FDIC will issue a Federal Resister notice shol11y fa< 60 

days or comm~tiiS pan or lhc n:gul.lr PRA cl""'oce p.-s and, durir~ the 

recuJar PRA clear1nce process. the .uitUted • ...,. ruponso time may be 

rH\'Iloated !wed on cornzne:>l.s 

naived. 

occ 

Tilloll/ ln/cmtGtion CtJI/oaion: 

Guidance on Sound lnc:ontivo Compen.utio~ Polic:it-1. 

~~8~~;:, ~~:~t~~i~;~45. F"'9utncy: Annually. 

Affe<ttd Public; 6uslnesw or other lor-profit. Rc.pondcnls: Notion> I banks. &rtmoled ••~mJ:• houn per respo~:se: 

40bours. 

Estimated numbtr of ..,ponlknts: 

1.650. 

Eslimottd toto/ onn110J burden: 66.000 

hours. 

FDIC 

Titlt of lnfom>olioR Co/loctioll: 

Cuid.nce oo Sound lnaotive 

Co•pensation Policies. 

~t:Y.:,:; :::t;.~t7S. l'ltquency: Aonuolly. 

Affe<ttd l'llblic: Bu•lnosses or other ror·profit. 

Rtspondcnls: ln!Urod SUtc nonmember bank.t. &limolcd u••croge hnun por response: lmplmnonlhl& or modifying policies and 

procedures: Ia~ respondents 460 

hours; .<ruallmspondents 80 hours. Maintenance of policies and procedu..., 

lOhours. 

Estimo"d numbtr of rtJpondtnls: 

Implementing e< modilyi•ta policlas and 

procedures: l..gc '"pondent>-10: small responde:nls-4,870: Mainte:nanct 

or t'~~:d':~~=~~u~::; 594~800 hours. 

OTS 

Tille of lnfonnalion Colkdlon: Sound 

Incentive CompenAtion Guldanee. 

~r,s~:; ~~~~ ~l~l29. Fltqlltn<y: Annually. A/fo<Ud l'llblic: a..;,..,.. e< cdtor 

lnr-prolit 

l!:<'po.C.ms:smncs..-u.as. 

EsUmottd .,..,.Jioars pu mpo.'ISO: 

40bows. 

Eslimoltd nurnbtr of rtJponWtl$: 765. 

Estimated latol annual burden: 30.roo 

hours. The Agencies have a continuing 

interest in the public's opinions or our collections or information. At any tin1e, 

comments regatding the burde-n 

estimate or any otherospoel olthis <:ollcction o£inrormation, including 

suggestions for rodurlng the burd•n. may bt sent to: 

llr>crri 

Sombry. Board oreo. ....... ortJ>o Fedml Rosorve Symra, 20'.h and C 

Slr1ets.~<1~ .. wasl-~ DC2055t. 

oa; 

CosomWlicatioN Di•isioo. Ollice or tile Comptroller of the Omency. 

Mailstop 2-3. AIUDtion: IS57..024S, 

250 E Slreel, sw .. Washinaton, DC 20219. 1n addition, comments may be sent by fax to (202) 874-5274 or by 

electronic mail to regs.comnrentstocc.lttJOf.30V. You n111y 

personally inspoctand photocopy comments at the OCC, 250 E S~eol, 

SW., Washington, DC 20219. For .socurity rr.asons, the~ requires that 

visitors :r.ate .. >ppointrnentlo inspoel oommena. You maydoJOhycolllna 

[202}874-4700. Upon arrival. •bitor< will be roquirod Ill pre<tnt valid 

gonmi!Wit·issuod pholo idonbfic:oUno 

and IGRihroit to ""'rily saeeni• i4 

order to insped and phOIOCOpJ comments. 

FDIC 

All comments should rtferto the name or the colloc:tlon, "Coldanco on 

Sound lncanlivo Contpoltl3tion 

Policies.· Commentsu,.y he •uhmitted by any or the following methods: • hltp:l!llww.FDIC.govlroguliJiioMI 

lows/federollpropo<t.hlrnl. 

• t.moil: comrnenrs&fdic.$0v. • Moil: Cary Kuiper (202.8983877), 

Coullltl, Fedmlllepasit lrt.!Utlnct 
83 


71718211.eps

Federal Regisler/Vol. 75, No. 122/Friday. )une 25, 2010/Nolices 36405 

Corporation, P-1072, 550 11th St.re<t, NW., Washington, DC 20~29. 

• Ho1td Delirety: C.onunants rna)' be 

hand·delivcred to the guanl station at 

the rw of the 550 17d> Str"'t Bui I ding 

(loco!Od on f Stree:), on business days between 7 a.m. and 5 p.m. 

OTS 

Information CollccUcn Cc))ron~ lls, 

Chief Counsel's Office, Offi<:e of'l1lrifi 

Suporvision, 1700 C Stroct, NW., 

Washington, DC 20552: send a facsimile transmission to (202) 906-6513; or ,.nd 

an e-mail to 

~~~:rfio~·::::~~=t~ indox on r. OTS lntemel Site a1 httpJI wWlv.ols.!roas.gov.ln addition, 

inlc!tSiod persono may inspect comments al the Public Re.lding Room, 

1700 C Street, ~'W .. Washington DC 

20552 by appoinlment. To make an 

appointment. call (202) 906-692Z, send an e·mailto public.info&ts.tre;JS ~ov. or 

send a facsimile transmission to ('2:02) 

906-1155. 

OMB 

Additionally, pl'"se send a copy of 

yo•~ comments by""" to: Office of Managcn:enl and Budget, 725 11th Street. NIY., 110235. Papen,orl< 

Roduction Proje<t (insert Agency OMB 

control number), IVashinglnn. DC 20503. Comments can alsn bo sent by fax to (202) 395-<\974. While the Regulatory Floxibility Act (5 U.S.C. GOJ(b)) doos not opply to this 

guida1tce, becau.so it is nol being 

adopted as a rule., the Asencies h<lve 

considered the potential impac:l. of the prop<l"'d guidanco or. small banking 

organi,.tions. For the reasons discussed in the SUPPUUEHTARY mFOJWAOON 

above, the Agencies bolievc that issuance of th.e Jlrt:lpascd guidance is 

neodod to help ensure that incentive 

compe.:'lsation anangemenls do not pose 

a thr'"t to the safety and $0undness of bankill8organi2ation.s, intluding sJnall 

b.mking organizations. The Soard in l.h.c proposed guidance $0Ughl comment OA 

wltether the guidance would impose undue burdens on, or ha ·e unintended 

ctutsaquences for, small organizations and whether there wm w·ays such 

potential burdens or wnsequences 

could be addressed in a manner consistent with safely and soundn~JSS. 

It i.~ estimated lhallbeguidanoe ~· ll 

apply to 8,763 small banking 

organi<alion.<.See 13 CPR 121.201. As 

notod in tho "Suppl•mentary Jnfonnation'" above. a number of 

con1menters expressed ooncem that the proposed guidance would in1pose 

undue burden ou SD13!1er organizatioBS. 

'!be Agencies have carefully considered 

the comments ror.ei,·ed on this issue. In 

response to theseeomments,tho final 

guidance includes several pro\lisions designed to reduce burden on smaller banking nrg3nization.(. For ftxampla, the 

flnal guidance has made more explicil tile Agencies' view lhat the (nonitOiing 

methods and processes u$Cd by a banking organildtion should be 

commensurate with U1e si?.e and complexity of the organiU~tion. as well as its usc or inoontivc compcnsatLon. 

The final guidonco also highlights the types or policies, procedures, and systems that I.BOs should have and 

maintain, but that are not exper.ted of other banking organizations. Like the proposed gu.idance,lhe final guidance 

focustS on those emp!O)'W w\10 haYe the ability, either individually or as part 

of a group, to expose a banking organization to material amounts of risk 

and is laiiOJcd to actOunt lor t.he 

dil!erenc~< b<tw .. n large and small banking organizations. 

V. Final Guidance 

Tbe text of the final guidance is,. 

fo\lOIVS: 

Guidance on Sound lnetnti.-e Ccmpensotion Policies 

l. lntroduclion 

Incentive oompe!'IS8lion practices in 

the financial industry were one of many factors contributing to the financial <risis that began in mid·2007. Banking 

organizatioM too (lf\en rewa.rded emp!oy88.~ for inc:n:wing the 

organization's Te\'811UB or short-term profit without adequate recognition or the risks the employees' acti~·it e:s posed 

to the organizction.

1 These practices wcetbated the risks and I= at a ntunbcr ofbanki.ng c:Mganizations and 

resulted in the misalignment of the interests of employees with the long· 

term \\'ell-being and safety and soundness of their organization$. This document provides guidance on sound 

lnocr.tive compensation pr.actioos to 

banking orgaoizations .supenised by the 

Federal Reserve, the Offioo of the ComptrollerofthcCUmucy, the Federnl Deposit Insurance Corporation. and the 

Office or Tldrt Supervision (collectively, the • Agencies").' Tbis 

'F:ataplesoltisb~~pte:ICIU.alb:u:IO 

d~~~·~~1bdS(IUr.dr..essltlclude 

ac<~a n...t.t. ~y.o,....iood,lqool, 

(Oit~e.l:xifl!lp'J':allionaltisb. 

tAsusedi:slllisgo~ll:C(COI'I"bir.'t\il~ 

(I!JlDiT.a~"' itdades !Wional b&nU.Sll:~ 

tO«l~bub.Sittt~r.Ot~berblnb.a.Y". 

~ioai: U.S.bld::t-.old flll<XIOpM!~U~ 

l."ldlo.l!!bolditta.opan5es.£dge.t.-..:5~'1C:IIelilt 

rorporatioM. w.<i:l a. U.S. opmtioM of to.aign 

Nnk.i1J3~l~~(tl0t~\(i:h•brl.~ 

~.Or~~tl(':ldlns;D'IIl'IIJ&."'Jin!Ac 

lklted~ 

guidance is intended to a.ss~t b.ln)jng organizations in designing and impleJnenting incentive compensation 

a110ngemcn~ and related polidcs and procedures that effectively consider pohmtial risks and risk outcomes.' 

Alignment or incentives provided to employees with the interesL~ of 

shareholders of th(t organiu tion often 

also bencfi ~ safety and soundn&<S. However, aligning c:nptGyee incentives 

with the interests or shareholdcr.s is not always .sufficic.ul to address safety·and· roundno.."-S concerns. B&eau.~ of the 

presenc. of the Fodera\ safety net, 

(including the ability o! insured depository institutions to mise in.sured 

deposits and aeoess the Fodera! Reserve's discount \~indow and paymeJlt services), shareholders of a 

banking OJS3tli23tion in sornc cases may 

be willing to tolerateo d'SJ"eofrisk 

that is inconsistent with the o~aniza.t on s safety aud soundness. 

Accordingl)',the Agencies expect 

banking ocganizalions to maintain 

incenlive compensation pr3ctictS tha1 

are consisteot with sa rely and soundness, e.ven when these practices go beyond those neodod to align 

shareholde< and enJployee inteoosts. To be con.slstent wilh sarety and soundness, incentive compensation 

.arrangemenls • at a banking organi28tion 

should: • Provide empl()yees inoonli\1ts thai 

approprial•ly holancc risk and reward; • Be cornpatible wittl effec;tive 

controls and ris:k·managtnlent; and • Be supported by strong corporate goyemance, including actiYI! and 

effectiveo,·ersight by the organiz.ation'.s board of directors. Tbese pnnciplas,and tho typos of policies, procedures. and systems I hal banking organizations should have to 

help eosurc compliance "ith them,'"' discussed later in this guidance. The Agf.ncies expect bonking 

organitations to regu,arJy revie\lo' their 

incentive compensation arrangemenls 

)"NSf!!l~tlldlht.Pfiuti:'JGJdltdaf 

bnd'l .ncw.sWMI witlllt:.cPrir'ICJp!u for ~Jill c.m,..,.,.,. l'loc/iccsu...lby ... fll>!r.ci>l SI01ily bd IFSBl ill Aj\(112Ct». and with lbe f'Sfrslr.t,o.lft.Nt~S.~Idcld$!oll~ 

poio<.plof.iso:<d!oSopl.....,...,. 

ID lhisplcf•xe.tl\et.a'. "illttr.tiw 

«ttl~·rerers1oll'.ttportMxlo1~ 

~!))oyee'sCUII\'fltorpc.:Miillcacopansa:iOAlhal 

isliedtG~O,¢c:ltC«'IIlt."O$pecific: 

l:lttria(~.&.•lo\'dof$tles.r~<finetJrnt). 

lo«n: i"'o-.perl$llio"d:~tSnotinc ucle 

OOfi'II*U'iioCIWth.M.~'oa:ded~} ~•and~ 

pt)'I'NllolwbidlbiOk.)lled I(I.(Odit.ued 

e:~pkyn:tKI(to&.stl&ryl.ll\.crditio~tot~tt;rl'llcbM 

lld.icdviJcc:orJpo:uallico~IDISt~Mt 

ISKet~:tlllod~delyMt.\ett~ploree slc.,..lol 

compe::t<Sdi.ocla.."ffibt!;DCil nlJba.t.edCCIOIItO( 

~tM~pakt!JNxe 111tt1k:$ (q..• 40J(t) pl•n ~le:­

""'lchl}-.eetg,'flit;~.~iollc:u:~le$a~l~ 

ot .. ....,~o, ... · ... t.ry). 
84 


71718212.eps

36406 Federal Register/Vol. 75, No. 122/Friday, june 25, 20 10 /Noti~ 

ror all executive and non-executive 

employoos who, either individually or 

as part of a group, have the ahilit~ to e.x.pose the organization to material 

amounts or risk., as well as to regularly 

rt\'iew the risk-management, control, 

and corporate governance processes related to those amng<men~. Banking or&ani7,.ations sltould immediately 

address any identified dellc:icnciw in these arrangements or processes tl1at act 

inconsistent with sarcty and soundness. Banking Grganiz,alions arc ~-ponsiblc 

lbr ensuring that their inCGntiYe 

oomp3n.Qtion amngmnents are 

consistent with lhe principles described 

in this guid.Jnoe and that they do not encourage employees to e.<poso the organitation 10 imprudent risks lhat 

may pose a thmt to the safety and soundness of the organization. The A&encies recogniu tltat incenth•e 

com~nsation artan,gemenls often seck to seTVe seven'll important and warthy 

objcctiv().S. For example, incentive compensation arrangements may be 

used to help attract skilled staff. induce better organization·wi.dc and employee 

pcrlormance, promote emp!oyoc retention, provide ret rem~nt security lo 

employees. or allow com~~tion 

expen.~e.~ to vary with revenue on an 

organizalion·wide basis. Moreov"r, the anoiJ•is and methods for ensuring that 

inct~Uive eompoosalion arraogemeuts take appropriate aecount of risk sl10uld 

be tailored to the size, complexity, business strategy, and risk tolemnoe or 

e:~ch otganizalion. The resources required will depend upon the 

complexity of ll1e firm aDd its use of incentive compensation amngtn,ents. 

For some, the task of dosigning and implementing compenstnion 

arrangements that properly offer incentives for c:xoculive and on ~ 

c.xccuti1,·eemployecs to pur:ruc: the: organi2ation's long-tenn well·being and 

that do notenr.oumge imprudent risk· taking is a complex task that will 

require the eommitment of adeq.,.te 

resources. 

While issues related to dasjgning and 

implementing incentive compensation am~ngements are eomplex. the Agencies 

are committed to ensuring that banking organizaliOJJS. move fOlWard in incorporating the principles dCSC'ribed 

in this guidance inta their ineenti\·e 

compensation praclices.s 

' loDeaab&20ML.itFtdt:r•IRcstm!, wutar.a aitnt.WOilM:~es.bo\.iti&h:claspdl~ 

~I:Ot:fal14'\'lt'.A'ofbcot.lll'\'l~:i.Qn 

~ClltJUldrd.t:edri$l~t.CIIX!trol. 

alldeotporatap'trlW)OIIpOOiu:sofaa.bMl.ixlf: 

~(Uia.~Thi.sillililfi\'IWJ;Sd'~ 

t<ISpCifandi:IOilitortbtladu.<l)"s~mtow.vd.s 

~~.cir~~pknlc:~lai~Mtl~reu.c ~I~"'· 

~~Lo..~:lr~l&ntirr~Cfliasbo;t 

As discussed further below, because of the .size and cornplexit)' or their Optr'i'!lion:s, LBQst~ should have and 

adhere to syste1natic and formaliud policies, procedures, and proct.ssi.S. 

These are considered important in cnsuril\g that inctntive compensation srransements for all r.ovored employees 

aro identified aud Te\

1iewed by 

appmpri•te levels of management (indudins l.he board of dircclots where 

appropriatoand oonuol units), and that 

they appropriately balan<e rim and te\'lards. In se\•eral pla~.lllis guidance 

specifically hightl,lhiS the types of policies. procedu.,.·es, and systems that LBOs should have and maint~in, but 

that generally are 110t e.<pecled of smaller, less complex organizations. 

LBOs warrant the most inten.si\'8 

supervisory attention because they are significant u.sers of in~ntive 

contpen.-.atiM arrangements and because flawed approachesot th.,. 

organiutlons are more likelj• to have a.dverseeffects on the brooder finaucial system. The Agencies will Wllli with 

LBOs as necessary through the supllrvisory prouss to ensure thatlhe.y 

promptly oorred. aay dclicicndcs thai 

may be ineonsi~ent with the sofely and soundness of the organization. The policies, proCedures, and SJ'I•ms of smaller banking Olg3ni,.tions that 

use incenti\16 compensation arrangements 7 are cxpoctcd Ia be less extensive, formalized, and detailed than those of LBO~ Supervisory reviews of 

incentive compensation macge:meJits at smaller, loss.eomplex banking 

organizations lVIII be eonducted by the Agencies as part of the evaluatlon of those orgaoizations· risk·nnuagemem, 

internal control~. and oorporate 

goveman<e during tho regular. risk· 

focused examination prooess. Thtst reYiews will be tailored tore0ect the seope and complexity of an 

crganization'saclivities, as well as the prevalence and scope of its incentive compensation arrangements. Uttlo, if 

~•r.d~~llwtst.ltool~core 

~IJblllcilldustty. 

•f01Sllp«Vls«'fpirpo$$$.tbt}.p::.0es~t 

=~=:.o~~ tbieec.$izo.(:Q'Ilple::Qty.t11dtl$kprolile.Fot parpGSCS(Iflllc~~I.OOsill(~ln:.bc 

,~'t_~~.'!~t~eyr~~~ 

~oiu*u~fiedbfi.M:P'tldeuiR«tc\"1! 

bf J:JVf:n'isoryflllrpostS:UillheOO::.Ibt~est 

4r4\1lo«coap!e-< Micfltl~bas deli~ i:11he 

~.o,.. .... ~-l>oolldoC~. 

Qxll('lt[l)r.tr'sl~.bock;~i9tbcFOIC.~ 

C(llllp)«lilwuttddtposi!Clf)'i~i:utiol:i(lOki:•lld 

[il·)lhears.~~el~ar.d!JIOI$I.co:~q~!e:xsaft!IS' 

ti50ci~andwi~arxllol11bolding 

tompMOies. 

'Thl$g.ui<b~dCieSI'Iot•Vfllytobanl:~ 

~iDtiooslbar:d!:ir.::KUWiinu•J:ive 

C:)lflpttlQi!Qc. 

any, additional examination work is 

expected for smaller banking 

organizations that do not use, to a significant extent, incentive oompensatiol\ arrangemenas.• 

For all banking organizations1 

supcn•isot)l findings related to incentive compensation will 00 communicated to 

the organizatioo and inc.luded in lhe 

ntlevtmt report of xamin~tion or io.spcttion. In addition, these findings ~viii be incorporatod, as appropriate, 

into the organization's rating 

oomponent(s) and suocomponent(s) 

rotating to risk·management, internal 

controls, and corporate go·mmao<e under thB relevant supen•isory rating 

system. a.s well as the org-anization's overall supwisory rating. 

An organiUltion's appropriate Fedet!l 

supervisor may take enforcement a<:tion 18aillil a Qanking organiUltion ilits 

incentive compensation ammge.ments or 

related risk-management, control. or goven1anu pfOC(l.$:$C$ pose a risk to the safety and soundness of the 

ruganization. particularly when the organization is not bking prompt and 

effective measures to correct the deficiencies. For example, the 

appropriate Federal supervisor may take an enfoi'Ql:rr.ent action U w.aterial 

deficiencle;s are found to exist in the organization's intentiYe compensation 

amngentents or related risk· managtment, oontrol, or governance 

processes. or the organization fails to promptly develop, subntit, or adhet'e to 

on effective plan designed to ensure that its incentivtcompensation 

arrangements do not encourage 

imprudent rlsk·taking and ate consistent 

wilh principles of safety and soundness. As provided under sec.1ion 8 of the 

Fedml Deposit lnsuranco Act (12 U.S.C. 1818), an enfor<cmcnt action 

may. among other things. require an mganizalion to take affinnative action, 

such as developing a cormcti\'e action plan that is acceptable to tlte 

appropriate Fedeml supervisor to rectify 

safety·and·soundness deficiencits in its 

incentive compensation amngements or related processes. Where wammted, the 

appropriate F'edera.l supervisor may require the organization to take 

additionaJ affirrnatJ1,·eaction to correct or Nntedy deficiencies related to the 

~T~f.ei~:.o•loso~.'.I·Me.a~e.• 

S1111!1etban~~--1dmle:wiue 

~J:rrir.plll«llslodtklnll~wJidhorll 

.sinon:.li\·tacper.$U~~e:~ISto.a 

SlgRi ~Ut:lexttc.tlult$bu$lr.0$$~[011$.A. 

~!kt bahllo,a o:pn~UIIU will od be c.oui&rtd •~lb!ttsaoll~~t.t~~ll.ive oorn(:nl.l!1iol 

"":1111aut'.ll. simplyb.nwelhe ocv~illlticn hu afim·ll'iikp:o11t~N~JJ.plt.,IN.Iis 

t.so.to:~IJ!ebortl:'s~.ablliiJ.e't'Cflif beplan 

COTetS.allcr!IOifolt~.l.dk.ct sw'i"~Of'.'CJo 
85 


71718213.eps

federal Regisler/Vol. 75, No. 122/Friday, june 2;, 2010/Notices 36407 

organitation's incen i~·e: compens.atlon 

pradioes. 

Effective and balanced inconliw. 

compensation practices are likely to e\·olve significantly in the comingycar.s, 

spurred by the efforts of banking 

organizations, supen1iso:s, and other stakeholders. The Agencies will ,.,;,w 

and update this guidance as appropriate to im:orpomte best pr.actices that emerga 

from these efforts. 

II. Scope of Application 

The incenti\1e compensation 

arrangements and related policios and procedures of banking organizations 

should be consistent with principles or saret)' and souudness.f'lnoenli\•e 

oompe.as3tion arrangements for 

executive officers as ""ell as for non· execulive personnel who ha\·e lhe ability to expose a banking organi-zation 

10 matcrialan:ouuls of risk may, if not properly stmctured, P"'" a threat to the 

organizalion'ssarety and soundness. Accordingly. this guidance applios to inC(lnlh·c: c:ompensation arrnn.gcmen:s 

for: • ~oior executi\•es and others who are Tl?..~ponsihle r{)r oversight of I he 

organization's fimi·Wide activitie.s or material business lines: to 

• lndi,;dW!I employees, including non-executive employees, whos.c activities may expose the orgaoi7.alion to material amounts or risk (e.g., t.rader$ 

with large position limits Ielative to the ocgt!Uizalio:a's overall risk tolerance); 

and 

• Croups oi employees who are 

:subject to the same orsimitar incentive compensation arrangemenlS and who, in 

tbe aggrogate, may'"'~""" the organization to material amounts of risk, cveo if no individ~l employ~ is likely to expose the organization to material 

ris~ (e.g., loon officers who, as a group, originate loans that account for a material amount of the organization's 

cre<litrisl\l. 

ttalbtCMoftlteU.S.optnlioo.soHUOs.tl-..c: 

019'iu:icn'1polidos. ir.dodl.•~ent. 

HYiiiW IIMhppt~llrtqDII~for ~U..S. 

opcnl.!otts..~fdbo~~odwlth l.bofB0"1 groop-wida polidas: cl!ftlcpd in llCONla!.ct~ tri~ 

It• ru!d oiL\cflJO's hoclwc:o:ll'Ar)' supcMsor. 1be poiKiaoflhe ftiO's U.S.open.l!ons si10t.11d 

akobtt«<iistrnlwi~:).of'SO'sl>'o·or.ll~ 

U>~lll.tJIIVollt:llslrlld.ue,.aswelluibfrw.."'lewort: 

(orl'W;..rD..~1 1n6i~IUKlll~ls.lrt 

011 Uepollckosfoc'tbeU.S.~al 

Fil()$d:o,1dbt~tt'll~l:lhl$pi!Wo. 

NScnicre:tta~lhwbcl~tll!li:nimt.u::., 

"txi!ICQ!IN<IffiC:rf~'!fJtlntba•Mili~oftbs 

Fodcnlltesuvo's. ~~011 0 (•12 O'R 

!~~~:~~~~c:r~~. 

~tDdEx~f.-~eissbt'smllrsoa 

d:.dosu."GGfmtvl.iYC~iOIII($r.l17Cf'lt 

229 .. tOZf•Vll..Sa.vinpiSIOriltlor.c~dl•!sc 

mtr i)OTS'sru1eo.Wmer"¥i~~~ion$ 

loth<'r~t'QI(iYeo(fiee.-s.d t(IC(on..•tldp:inci~l ...-r,ltn56l.ln 

for ease of reference, lhese executive and non-executive employees arc 

eclle<ljvely roferredlo hereafter as .,covaed employees" or .-employees." 

Depending on 11\e facts ond 

circumstances of the individual organization, the typeso( emplo)·ees or 

categories of employees that aro ou~ide 

11\e scope of this guidanco betause tboy do nol have the: abtlily t{) expose 1he 

organiulion to material risks w·ould likely include, ror example, teller$, 

bookkotpc!S, couriClS. or data processing personnel. 

In determining whether an employee, 

or group of employeos. may OXJlO"' • 

bankingnrgaaization to material risk, 

theor&anization should consider the full range of inherent risks arising from, 

or generated by, the employee's adiviUas, evtn i( the organization uses 

ri.sk·manaac-ntcnt processes or controls to limil tht risks such activilies 

ultimate!)• may P"'" lo the organization. 

Moreover, risks should be considered lo 

be matetial fer plli'J)OSe$ or this 

guidance if they are material to the organiution, or are material to a business line or operntill& unit that is 

itself material to the organization.1l F'or 

plli'J)OSe$ of illurntion, assume that • banking organiution has a structured· fmancc unittbal i.s material to the 

O!g!OiZ>tiOll .. ~group of employees within thllt unil whD originate 

s~ucturcd·financo transactions that may expose the unit to material risks should 

be ecnsideted "covered employ...,. for purposes of this guid;utce e~·rul if those 

transactions must be approved by an independent risk fu11ction prior to 

cor-.stJnlmi\tion, or the organization uses other processes or methods to limit the 

risk that such t.ransac:tions may present to the organi"taHon. 

Strong and effective risk·managemcnt 

and internal control functions are: critical tel he safety and soun~nesso( 

banking organizations. Howaver, 

irrespective of the quality or 11\ese 

functions, poorly designed or managed incentive compensation amn.gements 

can themsclves be a source or risk to a 

banking organization. For example. incentive curnpensation arrangement:s that provide employees strong 

incentives to increase the qanization's sbort·lenn revenues or protils, without 

rc&ard to tho short· or loog·tcnn risk associated with such business, can place 

substantial .strain on the risk· management 3nd int&rnal control 

functions of oven wcll·managed organizations. 

11 Thtt2$..ril&:u~.:fbetn.l; trilll llan~llir•Con 

-.ir~J~qo~~e.ottarae~tot.'lw.l~lms. 

th>NimtbolOI•""!'cltiGO>SIJitd;,, 

Moreo~·cr, poorly balanced iAcentivc 

compensation ammg<~ments can 

encourage fH'lll)loyec.s to take affinnali\•e actions to weaken or circumvent the 

Giganization's risk·mana.gcment or 

internal cont.rol functions. such as by 

providing inaccurate or incomplete information to those fu nctions. to boost the employee's personal compensation. Accordingly, sound ecmpensation 

j)I'3Ctices are an i1•tegral part o( strong 

risk-management and internal control 

functions. A key goal of ill is guidance is to encourage banking organi1.ations to 

incorporate the risks related to incentive compensation into their broadc: riskmttnagcmcnt framework. Risk- m.anasement proceduntS and risk 

r.onlrols that ordinarily limit risk·taking do not obviate tbe need far incentive 

compensation arrangemen~ to properly 

batance risk·tttk.ing incentives. 

Ill. Prinoiples of a Sound Incentive Compensation System 

Principle \: Balanced Risk· Taking Jncentives 

lnce.ntivtl compensation amngements 

should balance risk and financial results 

in a manner that does not enoour4ge 

employees to expose their organizations 

to imprudent risks. 

lnr.enti\•e con1pensation arrangcml!nts 

typically attempt to "'courage actions that result in greater reve!'tueor profit for the organization. Hm'le't'ar, short-run 

revenue or profit can often diverge 

sharply from actW!llong·run profit b&causa risk outcomes may becnme 

dear only over time. Activities that cany higher risk typically yield higher 

short·teml re~ enue, and an employee who is given incentives to ioCCMSO short·tcnn re~erme or profit, wilhout 

regard to risk, u·illnaturally be attrncted to opportunities to expose lhe 

organization to n1ore risk. 

An incentive compensation 

81rtng<~mcnt is balanced "hen the amounls paid to an employee 

appropriately tab into 3('b)unlthe risk< 

(including compliance risks). as well a.~ 

the financial benefits, from the 

employee's activities and the impaCI of those acti\•itias on the organiu tion's 

sarety and soundness. As an exa.mp!&, under .1 balanced incent.i10e 

compensation arrangement. t1"o 

employees who generate the same amount of short·term re\·e.nue CM" profil 

for an organiz.'ltion should not recet1·e the same amount of incenti\·e compansation if the risks t>kcn by ~~• 

cmpto)'OOS in generating tOOt revenue or 

profit differ materially. The employee 

whoso activities creato materially l.arscr 

risks for the ocsanil.ltion should !ettivo 
86 


71718214.eps

36408 Federal Register/Vol. 75, t\o. 122/Friday, funo 25, 2010/Notic:os 

loss lba tbo olhor employee, all ehe 

boiogoq .. l. The perhmanoe msa.surBS used in an incentivec:ompensation arrangement 

hove on lmponaJUeffctt on the inccntlv~ pmvidod employees and, 

thus, the potential for thoarrang< ment to encoura&clmprudent risk-taking. For Wlt'lple, ir •n employro's incenli\·e 

compon<ation payme.,llere closely tied 

i<>sborHemoreveaue«profit of 

bouilltSS pen ted by tho Olllp!oyce. 

wilhoutanyad;IISIIIIOIIU for the rUb 

...Utod wilh tbaboasinm!>"llonted, 

the potentiol for tbo .,..,,..,...t 1<> 

•llCOUnSt lmprudaot risk~ng may be quite strong. Similarly,uaders who work with positions that t iOSft at year· 

end could have an Incentive to take 

•~ge rlsl:$tow•rd the end of a year if d>ercls no mocmnism for fadoriQS how 

such posllioru perform over a loBger 

pericdofUmc. '111eSID1eresultoould IIISUt if the perfonn1Doe measures lhomto!WIIiack in!epiiJ or cu be 

IU!lipulotod iaapptOPriottly by the 

mployoes lflCO!vlna icanti• .. comperwti<ln. 

On the olhet lwld, if an employeo's 

incentive comfMin.sation parments ans: 

dcicnmincd b..oo on perfonmanoe 

mOMurosthaure only distantly I inked to the employea'• activities {eg., for most t~:mployee5, organiz.ation·t.,i de 

proliO,the potentiol for the armgement 

to """"""ethe cmplo) ... to W:e imprudlllt risks .. behalf oftbo 

orpaiutioo .. y bo ....t. f'or this 

....._,,piau that pnmide for owords 

bosod .. t.ty on 0\1!rlll organizltiOI!· wide perlofmanee are unlihly tG 

provide employom, olhcc than ,.nior 

oXJ~a~liYU and Individuals who have the obllity to materially affett the 

organlutlon's o•·orall risk profile. with 

unbalanced risk·takillg inceotiv.,. lnccntivo compensation a.rran;ements 

should not only be balanced in destan. 

they obo <hould bo implemented ,.thot 

or:tul paJIUI!IS YliJ bosod co ri$b or 

risk...-.lf,i:>rwmple. 

""Piol• .. paid >VhstmW.lly all of lhtlr potential i....,u, .. compeosation e\'tl2 when Nk or rUk outcor:li:S are 

mot!rlolly '"""' than expecled. en1plO)'el$ haveltl$$ incentive to avoid a<:tivltios with subslantial risk. • Bonklngo~g~~Joizalio sshou d 

considtrtha full raoge of r~l:$ 

associated with an employee's activities, as well as tbe time horizon O\'er which 

thoso risks Ill)' bo !Uiit.ed, in"""""" 

"hethct iac:tnli\'t COAlpe:uation 

~ISertbolaoced. 

'1110 octivitils olemployoes may 

<nlllo 1 wide mao ol risks fur a ba.WQS organiullon. such as aodit, 

marbl,liquldity, operotional.l'llal, 

oompltance, and repulolional ri.s k!, a! 

well as other risks to tbo riabo1ity « 

opmticn of the oqaniutioa. Soaoe of these risb moy bo re;olized in the sMrt 

term, while otltm may become 

opparentonly over the long term. For examlllc. futuul re\·e.nueslhat an~ 

booked as current income may not materialitc, and short-term profit-Md· 

loss measures 1na.y not appropriately 

renoct dur .... oos in the risks """'ioted w:ith thrtrenu.ed•i\·ed from diff.-:~1 

ICtiviti .. (e.&.lbt •i&hor end it« 

Clllllplia""' risk usociotod with 

SUI:prilllliow \'GSUS prime loo .. ~" In oddition,....,. risks (or combinations of 

r~ky SII>I'Ci" and positions) ""Y h>ve a low probobility of beil18 realiud, but would have highly adve~St effects on 

theorsomiza:ion if they were lobo 

realitod ('tad toil risl:s"). While shnre:holdcrs ntay ha~·c loss incenth·e to 

suard l&'in.ll b>d tail risb OOcallSt of 

tbo infrec;uoncy of tboir realization and the oxlsknce of the Fodenl safely MI. tbote risks womnt spec:W allmtioo for 

s.fely•nd·~-g;.-..lht 

thnat tboy pore to tbo 01p1izltioo's 

sol•·eru:y ar.d tbo Fodonl safety 11tt 

Banking Oll'•izatioos should 

consider lhe full11nge of current and 

p<>tMtial risks '""'iated with the acUviiJe:~ of r.ovcrod empiO)'&e.s, including thocostend amount of capital 

and li~uldlty needed to suppott those risks, in dO\-.Icping balanced inconth·e 

compansotioo "'""fl&tlll""ll. Reliable 

qu,.titsti\'tiiOISU!OSofrislcandrisk 

.. -("CJIIIIItil>li, .. ........., 

w!lere an.it.ble, ""Y bo porti<ubrly 

ustlul io dmtcping bWoced 

oompt,.,Uoo artang<meOts and in 

...... rngthoOl<l<ntiO which arrangements ue properly baiAAc.d. 

However, relrablequantitativt mwuru r.tlly not be aveilablc for all types of n.k 

or for all a<lh·itios, •nd their utility for 

use in compensalion anange.menls \'1~ aaoss. businw lines and employaes. Thuhsonce of reliable 

qu'"tiUiivell6lSUrOSforc:eruin types ol risb or OCIOOalOS doesiiOI.,.,.Ihot 

baokiQ&OfJ'Cizatioassbocld ipa<e 

sudl rbb or outco,., for purpose~ of 

WISSing wbdheran incentive 

compensation ana.n,gement achieves 

balance. f'ormmple, while reliabla 

quentitativc measures may not exist for 

many bad·ttll risks, it is important that such risks bo considered given their 

potential clled on safety and ,.cndness. 

.,....,.ut.J. IMtiiH:Mrizo:t.OM" no •rid. ..... .., ........... ~::,tN-. 

• ...,..,.....,.., ...... ,cru.plt. 

... ~._ .... ., .. bJ•• ......-.--~PIP"· .... ~--.tyMIIOIItyo:paRSik~IO 

-o.yaoblolol, ...... _,. 

CIJUI~IO .... Idi'J:I:W.tNIJUJbeiOIIili!'d 

"~'·'•'l""'lly. 

A$ in other risk·-!'""'· 

bonLq oqanizations should r1ly"" 

informod j\:dgment.s, •up paned by 

mil•hle dato,IO estimate risks and risk 

ouloomcs in the ohoenco of reliable 

qutmtit•tive risk mca.swas. l,o'),,. banking orgoniwtions. In dMigningond modifying incenti"" 

oompcosation amngement.s, I.BOs 

should .,.... in ad1·ance ol implcmenution wbc'Jlc< such 

....,._,ll.,. !iblytopro•ido 

lrolar:r:ad risk-IWI18 incoolivos. Simulation onalysis of inr:enti\'0 

<COlpen>otioc amngemenll is ooe woy of tloi~~&so· Such ar.alysis""' forward· 

looking projection> of iccentive 

eompemation a\vards and payments 

haotd on a11nge of perfornoance I eve b. 

risk outoomes. and levels of risks taken. 

Tbl.ltype Clf analysis, o·r other ana y~is 

tbat,..uiiSin.......,entsoflikely 

tffactivcness, r:an help "'LBO assess 

whether iDcecti\-e Q)mpcma:tiou '"'~ 

and pa,_,ls 10 en ompJoree arelilcly 

to .. roducod approprialely as tbo risb 

to the "'&'•izllooo from tbo e:nploy•'• adivltits incase. • An unbal.nced am.ngement can bo 

moved I<>\¥Ord bail nee by adding or modifyi113 fealures that cau,.the 

runounlsultimatcly roccived by 

omployoosto appropriately rclloct risk ond risk ootcomes. If en incan\ive oompensalioo a:nngemcnt may encourage tmp1o)'MS 

to export their bonkios orgar.ization 10 impNdeot risks,llot crgmization 

should modifythc~IS 

noecleclto-lhatitisc:oruislent 

nith safety ond ,.undn= four mtthod.!moftoowediOmaloo 

cnmptn..sation mora sensitive to risk. 

ThCS<l method> ""' u nlsk Adju$1mtnt of A•~rds:'rhe 

amount of an inccnlivecompcn.s:~tion 

•ward for on employee ~adjusted b..oo on mwuros that tab inlo account tl:.e 

M< tho employee'• activities may po10 

tr>lheoqanization. Such.....,.... Ill)' 

.. qUODtiWiva,«thtsi,.ofarisk 

adjustmontlllly boJet ~tally. 

subjoct 1r> appropria:e ov!ISiglol ~ Dtftrmf of Poyment The actual 

payout olan award to an employoe ~ 

delaytd •ignific:antly beyond tho end of the pcrfom~ance period, and the 

amounts paid '"'adjusted lor actual ).,.es or other aspects of performance 

tbataro realized or becoona better 

kr.own only duril181he defeml 

period.'' Defoned payouts may ho 
87 


71718215.eps

Federal Registcr/Vol. 75, No. 122/l'liday, June 25. 2010/Notices 36409 

aJimdiiCCOII!iJl&IOrisl:OIII<Oa>eS 

either lonnulalally or judglneot.lly, 

subject to apJ)IopriotooversigltL To be m05I rf!ectivo.tht dclmal pmod 

should bo sufficlontly lo"8IO allow for 

the ... u,.uon of asubslanl~l portion of 

the riskJ from employee activities. and I he mmu"" of loss should be clc.vly 

explainod to employees and cl...,ly tied 

to thcir ottil'ities <!uri,. tho rete ... , penon..,.. ,.nod. , lDn:tt l'tt(OIIIIUIIC1t Periods: 1\a 

time pmod CO\'II'Od by the perf«manco 

measuras wed in dctenniniag an employoo's aw;ud is extend«! (for 

example, from ono yoar lo two or moro 

rem).l.ongor J*fonnance periods and deferral of pa)'mllllla .. rel•lod in that 

boih methods allow owards or payments 10 be Nde oll<r somo or all risl: D:llalat<s Itt reolized or hoUtr I:Do~>'ll. 

c RtducrdStJW!ivilyiOSho:!-Ttm 

l'elfonrt<Jnct:The bonking ocpniulion 

reduces the 1\lto at whlc.b awards 

increase as an employte achievc.s higher 

liRVtll.$ of the roJ0\1

0nl perfOnM!lC8 

mcasure(s). Rathert han offsouing risk· latins incenti\'M associlted wil.h the use ol shorwm perf0111W1C0 m....,,.., lhismedlod reduces IM~o! 

suchi,...li...,_ 'f11ismolhochlsocon 

intlude lmfi'O'i~ the quolily and reliability of perfurmanct measures in 

~>king into account both short-term and long. term ri.lks. for w mple irupro1ing 

lhe.,liabllity and act\Jtoey of estinllll& of rmnues and long·lenn profits upon 

whicll perform.~noo mc:uures deptnd." ,_ tG<Ihods 6Jr odlit>i"8 balaeco 

............. l't,tndadclitioaal 

methods or variatiooo moy exist cr be 

da-.lopcd. Moroovcr.cocll method has 

its o"n ad van~ ond disadvantages. For CllOimplo, whero mliable risk 

measure.' exbl, ri!!k ad u.~tment of 

awards may he moro eJTccti\'e tha.n 

dclernl of paymtnl in redu<i"8 

iocooti'os 6Jr lr.lprodonl risl:·taking. 

1\is is ......... risl: odjlulm<nl 

po:eoti.tlly c:aa IW """""'of the full range and bme ho:i""' of risks. rathO< 

thao just th010 risk OUicat.lOS that occur or become mort ovidenl during tbe 

defcml period. On I he other hand, 

defcml of payment mar be more effective than rbk •djusllllenl in 

'l'fliooiO 

~Adti2IDOI(UU.$.C.?UJ!,Widl 

__ ___ _._ ,,.........,. ....... ~ 

.. ...p..tb-r;>o*c,tol"diJ.>ocY 

qqgii'DB. 

•4tu!~LUJIIUD4JM'tt&ll'.&tria.!tlect 

oe~cwl~i •. Wuzsets•1ofiet tM~'eOiil (tt.Mtf' ftw&rds .forilll(fSioaiiS of 

pdorruna~ thai w*'-'CI~ i.i¢.C or JUY proviJe ININ~~ck will bl&*iododyif a Urs« 'iSa~~•at.eldtLbl~tMfbepwlinllL-tt 

&OCivt."AdiOklt~~~--brwil __ ...... _"" ........,. ....... 

miU&~tins ;,_,i..,to IW hard~<> 

.,....,. risks ($orcb ostho risks of r:cw 

activititsor pn>:!octs. CO'artoio risb 

such u repulatlon.IOJ oporational risl I hat may be difficult to mwurtiVilh ""PK' to p>rticular adiliUC!$), 

etpec:i•lly if such risks are likely to be 

reallud duri"81he defectnl pmod. 

According!)'. in srur.e:casa h,·oor men 

meahods mty be ooeded In """bination Cot an iADtAliw: co:opu..gtion 

""""""""ttobebolon<r>d. 

The pul<t the poten!W IDCOCtives .. omng<mcnl cn:ales for an cmplo)''" to lncrouethe ri.lks asoociatod 1<ilh the emplo)'et's 2ctiviUM. the stronger the 

effect should be of U1e mtthods applied toocllievebalanf.S.TIIus, for example, riu adjUSIIDents uzed to counteract • 

matorial!y unb.alinctd COIIlpensatioa 

amngaoeo: .booJd itol't I simil&rty 

material itDp3Cl oa the incantive 

cornponsotion paid under the arrangem<nL furl,.., improvemenl.l ia 

~" qunlitpnd reliability of porfonnance measuresthamsel..,, for ex~llp e improving the reliability and accuncy of estimates or re\·em.1es and 

profil.l upon wh.ich pedom>ar.ce ,......,.. depo:lcl ao sipilico>~y 

ir.piO"Ittb d~ofbaiiiiCOinrisl· 

tW118*-'Ii'-es. 

ll'liin judgment pl•ys t •lgniRcant role in the design oropentlon ofan 

incor.tlVG compcos.1lion amngame:nl, 

strong policios and pmoodures,lnton>al CODIIOb. and ex post monitoring of lncolllin compeosolion pa)'lll<nts 

!<lativclooctualrisl:ou"'"""""' 

particubtly imporllrlt lo .. lp oc.sure 

that the~as implcmtnlod ... bol...:ed :md do not.....,. 

imprudent risl:-!okiog. FD.'•xamplo, if a booking Olg'nillllion relies to e 

significant degree on tho judgment of one or ruOJe managtn to ensurethnt tho 

incenti\·e compensation awards to 

employees are appropril:aly risk· 

adjwlecllho o:pllt>lion shocld hal·e 

policies and ~wosthal claaillo 

how managors"' expeclod to wrciso that judgrne:1t lo achin~ balonce and 

that provide for the rnanager(slto 

re<:cl'o appropriate available 

inf€1rmation about the employee's risk· 

taki"8 activitietiO male informed 

Judgmmts. 

l.orp llonliog Ol)lOIDWiion~ Methods and pradioes for making c:oarplllll!ion 

sonsitiwetorisl:.n:lildyto"""vo 

npidly during the aext few yoors. d~"n In part by the efforts of supervl.,. and other stakcholdt<S. 

LBO. <hould actively monllor 

dmlopments in the field and should 

Incorporate into lheir incenlive 

comper.s~tion systems new or emerging 

methods or p<Odices tltatnlil:aly to 

irnJ)IOI~ lhtorg,r.liD!icn's IIJCitln 

Rnanci.tlwell-bei .. md afdy ond SG!Uld-. 

• ,. ........ u.wbaabanliog 

organization seeks to tchievo bolanctd 

=~~:n:d:~j:~~~~~:ts 

differences between employees- including tha •ubstantial diffe....,ces 

bctww senior execuli\!es and other 

employ-. well IS bee,.... bankilll 

organWliGnS. 

Aclilitl&. and rbb .. y ''UJ 

$ignifocoatly both ocross bonlilq: organizations and across employees 

within a particular banking 

Ol}1ani7.0ltion. For b.lantple.activities, risl:.s, and incentive compensation 

pnldicos may iffcrm.~teriolly among banki111 orsani11tlons b>std on, among other thiQC<.lho scope or Q)lllplexity of ltlivitios condu<tod and tho bus; ness 

sl.'IIACies pwsuedby tlta orpniZiilions. 

'!'Mit diffmnces .. ..ac th2t methods I« 

achieving bal:mctd cornporuation arra~znenLt; 11 on.o organization m~y 

not be effecth·e in restraining centi~·es 

to engage in impntdcnt risk-takingat .another orsani1.41io:.. Each organiz.alion 

is ruponsiblo fotensuring U..t its inoeotii'O -ponsatioa amngements .... cnosisltnt v.ilh tho A!tly and 

~f=.f:.·r~"'th lhc activities of one Jl'OUP or non· executive employ"" f•.g., loan 

originators) \oJlthin a banking 

organization may differ significantly 

from tltoso of anothor group of non· exeooli•o anplor-(,_spot foreign ~traders) witlWt lite 

orplliution.ln addition. rdWlle q=tiutivo rntasura of risk .. d risk 

oul<omos are unlikely to be availahlo lor a banking Ol1!anl,.lion as a whole, particularly a large, complex 

organization. Thfs r~ctorcan make it difficult for banking "'¥4-1iutions to ach.ie\·e b.JI~~:nced compe:nsatio:. 

am.-ts for sen!oruecutiv.s ,.iro 

~u ... responsibilil)' for m.ln>Ci"& risks 011 an orpniutioe·wide lrosis solely lhnl~ use of the risk .. djust.,..t .. f· 

award method. 

Fu.otltermore. the payment of deferred 

incentive compe S~Uon in equity (such as ,..!rlctod stock of the organization) or equity-based ilUirumenl! (Sllch as 

optior.s 10 ICOJUire thtorpoizatioo's 

stocl:) 1111)' be bdpful in ...u.inirlg tho 

rist-Giilq:IMOIItivaofsmior 

executiva and Otha' co>N an ploy,.. 

whose activities m.ay ha,·e a materi.tl 

effect on lhc overall financial 

pcrf'Olmancc of tho OIWJnl-xalioo. 

Howe"'· cquily·rolatod deferred compe:n~lion may not be as effecth·e in ~raining the ineenlh't.' of lo• -er·le\·cl 

a><ere<l e:rnplor• (ptrtio>latly •tlarge 

G~ptimi<w) to tW risb blall!l suc.'l 
88 


71718216.eps

36410 feder<~l Regisler/Vol. 75, No. 122/Friday, lune 25, 2010/Nolicos 

employees are unlikely to believe that 

their actions will materially •ffect the organization's stock prioo. 

llanking organiutiOilS should take 

account of these difforcnctS wbe11 eorutructing bal3nccd oompcnsalton arrangeoenls. For most banking 

Of&'lnitalions, the use or .a single, formulaic approach to making employ .. incentive compensation arrangements 

appropriately r~k-scnsili1•e is likely to resull in amng.ements thai are 

unbalanc.ed at least with respecl to some employees.•• 

lotge bonking otgoniztJiions. 

ln~ntive compensation arrangernent"i for stnior execuli\•e..~ at LEOs aro lt~ely 

to be better balanced if they involve defmal of a subotantial portioo o! the 

e.\:ecutives' inamlive compensati(Jn over a multi-year period in a way that 

red~~ the 1mo~ t ooi1·ed in the evenl of poor performance, s.ubstantial 

use of multi-year pc:rfonnancc periods. or both. Similarly, the conopensation 

arrangements for senior .xetutin~s at LBOs are lil<ely to be better balanad if 

a significant portion of the ino::nti\•e eompetlsation of lheseexecuti\·es is 

paid in tho form of cquity·basod instruments that vest ovtr mulliplc 

years:. ~"ilh the number of inst.rumcnts ultimately received dependenl on the 

performance oflhanrganiution during the deferral period. 

The pOJtion of the in«ntivl.! 

compensation of Olhcr oovcred 

cmployoes that is deferred or paid in tho fonn of equity·based instruments should 

appropnately t>ke intoar.count tho 

level, nature. and duration of the risks that the employet\S' activities create for 

the organization .and the extent to which those activities may materially affect the o\•erell performance of the: O!g8ni:zalion 

and its stock price. Deferral of a 

.substantial portion of an cmplorec's incentive compensation rna)· not 'be workable for employees at lower pay 

scales beotUSt of their more limited 

financial resources. This may Nqll.lire increased reliance on other measures in 

the incentive compensation :nrangtrnents for these cmployw to achteve balance. 

• Banling organiz.>tions should 

carefully oo ~der the potential for "golden paraclmtes• and the l"e.<tlng 

;nmnger.1ents for deferrOO compensation 

" for ~lllp1t. ~pr~ift8Jllll}'<lllbolinoect.h._ 

c.on'l~io l~wa.-dsov«•SWidt.-dtluoeo)~r 

pe:lodl'la)'n3!-w~1 yreflocubtc.itT~ 

fntbt wetodtilHboriz.ooolrifkasaoc:ia edwi:h 

tbeldit51iesoldi1l't'ftlllpp.sol~od 

r.&)•DOlbewffici«.tb)•i:.dttobibi'ICethc 

(l)lr.peutlion.~etltseltt~ployCIII$ .. t~,..y 

C.'lpolll:tliM:o~iQ(toi:I.O~~ ~ODI 

ri!b. 

to affect the risk-takil!J! bch"ior or empl\)}'e&S while at the mgt~nizaUons. 

Arrangements that provide for .an employee (typi<>lly a senior executive), upon departure from the organization or 

a change in control oftheorg,aniu tion, to receive latgeadditio11al paymenls or 

the a<tOimted payment of deferred amounts without regard to risk or risk 

outcomes can pro..,ide the employee 

significant incxnti\'cs to expose the 

organi~t on to unduo Nk. P'orCX3mp!e, 

an ammgc.-nent that pro,•ides an employee with a guaranteed payout upan departure fmm an organizatio.n, 

rq:ardl._<S nf performance, may neutralize U1e effect of any balancing 

features included in th•amngemant to 

halp pre•·ont imprudent risk-taking. 

Banking organizations should carefully revie\11 any such existing or propascd amngcmcnts {somclimcs 

called 'golden parachutes") and the potential impact of such arrangements 

on the organization's safety and soun nes.~. In appropriate 

circttmStances an organization should 

consider inclnding ba onci~ features- such as r~k adjustment or dafeml requirements that extend pasl th.e 

eo1ployee's departur&-in the arrangements to mitigate the potential 

for the amngemoots to encourage imprudent rlsk-taking.ln all cases, a 

banking organiution should ensure that the structure and terms of any golden 

parachute arrangement entered into by 1he cxganization do not encourage 

imprudent r~k takiog in li,qht of the other features of the employee's 

i'1cenlive compensalion arrangements. 

14tge banl:ing orgqniwlions. Pro'risions that require a departing 

employee to rorfeil dcftJrred incentive compensation paymenU: n1ay weaken 

the effccti•·enoss of the deferral anangemcnt if the departing cmployoe 

is ablo to negotiate a 'golden hand~baktf arrangomenl with tho new 

employcr.•&This woak.cni11.g cfJod can be particular(y significant for senior 

executivO$ or other skilled employees at LBOs whose services are in high 

dcm3nd IYithin tho m3rkct. 

C.ldcn handshake arr•ngmnents present speci.'!l issues for LBOs and 

supervisors. F'orcxample. while a bank.ing organLzaiion could adjust its 

deferral arrongcmonts so that dcpaning 

tt:'lployees ,..,;n continue to receive any aCC!'\11\d defeCTed wmpensalion after 

d•p.1rture (subject to any dawbock or 

••Colda~•re,mr.ptr.Utbll 

«aptnsalun e.p~ tor$00M oull Gf11M iBt:ed ~.tdval~of&!tmd!ll(tdi\'t 

l'J):I~ior\ll-Aio!'Otlt4bt\'\\t.'l!(ddcdt.:I)CII 

l.rpa:twe rl'IOlhMiplo)'M·spr~ 

0).1~!.. 

malus"). those cha"ges could reduce the employee's incentt,·e to remain at 

the organization ilnd, thus, weaken an organization'sability to retain qualified talent, which is an important goal or 

compensation, aod create conOicts of interest Moroo..,cr, actinn.s of the hiring organizalian (which may or mlty not be 

a supervisod banki~ O!llanization) ultimately may def"t thes. or other 

risk·balancing aspocls of a banking organiution's deferralarrangemant.s. UlO.s should monitor whether golden handshake a!Til.flgcntcnt.s are materially 

weakening the organitation ~ efforts to 

cotastrajn the risk·taking incentives of employee.s.l11e :\gencies will conlinue to work with bankjn.g o~g.anizatio s and 

others to de elop 8ppropriate methods for addressiog any eflec{ that such arraJ18ements may have on the safety 

and soundness or banking o11aniozaUons. • Banking Ol!!ani~lionl ~~o ld 

cfTccti\'ely cumnnUlica.te to employees 

the ways in which incentive compensation awards and payments 

iii be reduced as risks iocroaso. In ordcz for the ris.k·sensili\·e 

provisions or incentive oompensation aJTaltS<noen~ to affect tmplo)·ee risk· taking behavior, theo~an za ion's 

employees need to understand that the amount of incentive compensation lhat they may receive will vary based on the 

risk as.\Oeiated with their activities. Acterdingly. banking otganiutions should ensure that employm covered 

by an incentive compen.sa!lon arrangement are informed about the key 

~v~ys in which risks aro taken into 

account in detennining the amount of inccnti,•e coropcnSJiicn p3id. Where 

feasible, an iu.tion's 

communications with employees should includeexarnplesofhow incentive: compensation payments may be 

adjuSied to reflect pro;octed or actual risk outcomes. An organi?.ation's 

coromunicalions should be tailored appropri>tcly to reflect the 

sophistication of the relevant audience(s). 

Pnnciple 2: Compatibility With Effi!<6ve Contro~ and Risk·management 

A bankingoos>Oiution's risk· 

man~geme l pnx:esses and internal controls should reinfcm:e and support the development .nd n~•intenance of balanced incenU\•e compensation 

amngemeols. 

"A auii:SaorqarD~C)l pennilJI!'Al ar.p!o)'e: 1.0 

ptt\"(11:1..-estlQSolall«t»:'loltheDMftiDiola 

i!ritcrtd !MuCOMiU:I au~fd.MI!I.:$ provisio.'lSltt 

[nYOb::i 1M rbi«JQ31:1e51.1t WO."'SSIl:.an 

txpec:~Morv•h~ tM~1tooupon 1KbK111.be a~.wdt>"Ubt-rum5outl61ui 'Cbocr1 ino:md. 

Lmol.:~rwcalcd<Oe:.~dt.:ot4o i:e tlr.p!oyM 

~';~~~-~1:~-:~~;~?feol 
89 


71718217.eps

federol Regisler/Vol. 7S, No. 122/frichy, June 2S, 2010/Nolicos 36411 

laordwco inaase !heir.-., 

COCllpenlllion, omployoos "'AY aei to 

endolhe p10eases escablisl\ed by a b.Jnkins org.11iution to achieve b313rtc00 COll\pens:~lic!l arrangements. 

Simllorly,on e01ploy,. ''"""'by an lnocnti~·o compensation arraAgcrncnl 

m~y *k tn inOuenr.c. in ways designed to inc:rouelhe employe&"s pay,lhe risk measi.II'Q or other information or 

jwlglncncs lhalore ued Co make lhe '"'Diovto's pay ...Wti\"Oio risk. ~oai<lasmay sipiliancly 

...U..llooofloctinr.essolon 

«pnlutlon's ia'*'ti"' <0o:1pen»tion 

arnnaeruenos in ralricting imprudcnl risk~o1kir-8. Thesa :K:Iions can baw a particularly dam'3ing effect on lhe 

sefety end .. undncss of lhc ocganizalion if ohcy rosuh In the weakening of risk rneasures, in!onnalion, or judgments 

that oho orpni!Oiion us.s for o;bor risk· 

"'~'"~ iolomal <oniml,or 

fiAulci.IJ pw...,..._ln sud! cosos.lhe .. p~o,..·, OCI.ioAs ... y .....u. not 

oofy the bal.nao ollho «giiliza~'s 

lncenti" CIOQpensation lmliF'""Is. butalsolh risk-~. ioternal 

conlrOI!, and oU>er fundioR$ U..l .,. 

•opposed lo act IS a separate chtck on ri>k·taklng. for this mson.lr.ldil.ional 

risk·rMn3.gcrncmt conlrols alone do not 

oliminate che n,.d to idantify 

employM.S who may expose the 

~nlution 1o material ri>l:, nor do tbcy obviate tbc need for lhe inamtivo 

CCII"IIpwation amnge:r:aots fa these 

.. p~oyoes lobo balooood. Rath.-•• bonklns....,i:nliao's risk-aoaD~emall 

proccssos and inl«noo Q>nllols sl»old 

reinforcuad support the ciemopmO!II ar.d malnleMnco of balaRA:od i""'nti•e 

CO.'l..tperuation arrangements. • Banking organization.~ should hne llpprnpli~tc oontrols to ensure !bat thtlir 

p~ for achieving balen<od 

compensatioa amtlgements are followed and to maintain tho integrity or 

thoir risk·manogo:m .. t and o:her 

functions. 

To lotlp pm"OOI duoo:go 1rono 

OClCOifliiC. • ~~Wins oq;onmoioa ""'•'d ha"'MlaS"'•Orolsgonming ics,...... (or deslgnins. impl..,enting, and monitorin, inc::enti\'1!1 compms:llion 

amtJ18tmoncs. Bankingocgaruzations 

shlluld ctt'te and maintain sufficient 

documentation co pennltan audi 1 o(lhe 

effectivene.s.s or the otganization's piOCOSIIS (or establishing. modifying. 

and tDOnitorina inamth·e compensaticm 

"""F'IIIt~ Sm~ior bat.l:ic& 

orplli,.lioru should u.x.ponte 

miows of dotso (IIOCISSOS into tbeir 0\'mllhlroowwtloroompliu:oe 

moniloriro~ (!oclllding !nt<mal auditl 

l.orp 60nl:ing "'8"niwtions. LBOs 

sboold hav.,nd maintain policieuud 

proo:ldurM that [i) idru>tify 111d d!SC!ibe 

lhe roloUI of tho ~.busi,... 

units, and CDOltGI unics authorioool 1o bo Involved In lhe dasign, iaopiA:uoentltion, and monilOriJtS or incentive 

compen.<3tlon am~ngomcnts; {iil identify the •ource of s]$nificanl risk-related 

inputs iAio these p..,...... and establish appropri<tlc <onlrOis govoming the developmenland approvol of these 

In puiS to help ensurtlheir inleglity; and (iii) identify the indi,idual]s)and 

<onln>l unit($) ,.hoso appro,.. is 

._,for lheestablis!u:leloo oi- IICG6\-.octmpas.lioo~IS« 

mcdilicaoion of existi"3amngomllliS. Aa LBO also 1hould <onduct r<gular 

internal reviews 10 ensure that its 

proowe.s for achieving and .Nintaining ~lanwt incentlve co1npensation arrangements: are consistently roliO\l.'ed. 

Such re•·lcws should be <onducted b)' 

au<llt, coonpliance, or Olher personnel in 

m•nrtOr..,.,.~t .. tllilhth 

"'l!'Odutlon's 0\-..11 boolewmt (or 

C010plilncero:onil1Jrin&. An LBO"s 

lnt.nal audit depwncol also ohould 

Slplrltdy corullld """" aau!its ol the organitation's complimce with its 

esoablishod polities and controls 

relating to inOMti\'e compensation 

omtngemcnls. ThoiOSulls should be 

rcpor1od to appropriace le•als of 1nan.mcnt and, where appropriate. tnt 0'8'Ritalion"s board o( d.iroc!Ori. 

• Appropriaoc personoel. iucludi•ll risk·manteemtnt personnel, Jhould 

hnelnpo:l io:o lheo.~ioo's 

processes for~"' iooenti\"0 

oompo=liooa..,.....LSa:od 

WU$i~ tbeir tfftcti\-eoess ia 

rlllniniq imprudeol risk·taki"tg. 

Developi'1 •ncenti\'S compensation 

ornngemeots tlta: pro\ide balanced 

ri.sk·taki113 incentives and monitoring 

arnngemenls to ensure they achiove. 

balance over time requires an 

undcrsanding of tho"'" Oncluding 

compllonc:e risks) and polenlial risk oult.Oine.s associated with lhc aaivities of I he rtlevanl omplOJ-. Actordingly, 

l:ankirtCcrpoltalicwsloouldb..-. 

pol idol and procedures thao mwnlhat 

risk·.....-• pmonocl ~~a .... oppropNie role in lhe organizatio.•'s 

~for dl$igning incenth-e 

"''"ponsetion arrangements and for W6S.Si.og their effecti\·eness in 

resualnlng lmprudontrisk·laking." 

Ways lhat ri>k managc:s might ossisl in trhieving l~lan<od a>mpen.<alion 

amnger:unts iacluds, but a.re r.ol 

limiled to, (ilreview~c& thei)"Jl<S of 

n.b IS.10CiaiJcl •rilh lht :K:Ii;ities of 

C0\'1nd omploj'OO!; 6il appnrri!os che ri>k mouiiJtS ued in rishdjus!Menc. 

ond perfcmwoce mtaSUn!S, as well as measures of risk outcomes used in 

defemd·paycutamngements; and {oiil 

onaly;ing risk·laking ._,d risk outcom" 1'\ll~livo to lnct:nlivecompensation 

Jl3{)';~:'f~ncUons withi.n an org.anitation, such as iiS control, huma.n ....,......., or fi .. nce fomclions, also 

pia)' llllmpoll&nl role iD loelping ..,.... that i~lin (X):npusation 

.,.,..._LS.,.bolanced. For 

wople, these fwlctions may <onlribotle to the dosicn aoul review of performance 

maasu."tS used in comptnSation 

arrangomonl< or may supply daca u...J as ptot of theso measuras. • Compensation forcmpiGyees in risk·mtnagemeut and tontrol functions 

should bo sulncienlto allract and relaln 

q"'lifi!d ~"!!nnel and should 1\~d 

conftids of iniAin>sl. Tlo&risl:-~a:odamln>l 

porsoond io\"Oh-ed in the desip. 

ovenia)rt, Uld opontion ol inmoti•~ 

compo:wUon anangemencs ohould 

ltavo •Pi'fOprule skills and experience nt!t!dcd to cffect£\·ely fulfillthoir roles. 

Those skills and experien"" should be 

sulnclencto equip che personnel to 

1'\llnain o.ffocti\'C inlbe face Of 

rhallcnges by c:overtd employcos 

seeking to inacase their incenth·e 

compensation in ways tht are lnconsistanl 10ilh sow:d risk· 

.....,....,c,.intemal""'crols. Tloo ClnpelllitiOni~':Sfor 

tmpioywinrisk~cand 

con110l fwoctioru lb., should he 

sufficient co attr.tctand ®in qualified 

personnel with experience and expertise in th6SO fields that is appropriate in 

lighl or lhe si,., a(:livilies.and 

<omploxicr of lhe orsaoization. In odoiuon, oo help preserve the 

iodcpcndtn<O of their perspcclivcs,lhc 

iact:nth·c oompensatioo n:cci\'td by 

n,< .... ,....., ... d OClltrol '*"""'" su« """''d DOl he Nsed substanti>lly 

"" '"' finana.l perforrnaJQ or the busiaoso uoiLS lbacchoy miew. R>tlter, 

tht por(ormanco """'""'used in tho inctDtift compensation arrangements 

lor these personnel should be based 

pr1marily on the achiew~ment of the 

objocll•os or their functions (e.g .. adheren1>1 to htlemal c:onlrols). • Banking ocgaoi,.tions should 

monitor lho perlonnan1>1 of their 

iDtenlinan:tpenSIIion arrangements 

ad should mtso thearnogarroncs" ....w if poymeoiS do DOl 

fOI)dac.ly rdled risk. ~\ina a~ni:z.ationssbould menitor inctntive(X)mpensation awards and 

poyments, n,;, tabn,and actual risk 

ouloomos 10 delermine whelhar 
90 


71718218.eps

36412 federal Regisler/Vol. 75, No. 122/Friday, JuM 25, 2010/Notices 

inc:tntive compensation paymeots to 

employees are reduced to reflect advmo risk OUt<OJnCS Or high levols of risk 

taken. R.,ull.sshould be reported to appropriate levels or management, 

including tho board of direotors where wamnted and consistent with Principle 

3 belo". The monitoring mothods and 

P""""" used by a banking 

organiuliOtl should be commen$Urale 

with the siu and co"plexity oftl\e 

organiza1ion, as well as its usc of 

iaccntivc compensation. Thus. fo·r example, a small, noncomplex 

org.ani:tation that uses incentive 

r.nmpAnsaticm only to a limited extent may find that it can appropriately 

monitor its arrangements lh.rougb nomtal management processes. A bankingorgani1.ation should lako 

the results of such rn<lnitoring into 

acwunt in e.stabl•shingor modil'ying 

inoentiv; t.on•p;nsalion o<T'Ingem!ntl 

and in overseeing associated eont.mls. If, over time, incentive co&!lpensaticm paid 

by a bankingor:ganizalio11 does not appropriately reflect risk outcomes, the 

rxganizalion should review and revise its incenth·e compensation 

arrangement$ and relat~ eontrols to ensute U~atthe ammgtntents, as designed aJld implemented, are balance<~ and do not provide employees incenti\les to tako imprudent risk:s. 

Principle 3: Strong Co•porato 

Go\•emance 

llonking ~altizations should bave 

strong and effoctive corporate govcmanco to help ensure sound compensation practices, indudin;g 

ach~.-e and effect.ive oversight by lh~ 

board of directors. Given the kO)' role or stnior 

executives in managing the overall risk· taking acli\•ities or an organization, the 

board of directors of • hanking 

organiution should directly approve 

the incentive compensation arrangements for senior executives.~& 

T'ne board also should appro''' and doctuntntany material exceptions or adjustments to the incentive 

compensatio:. arrangements established 

for senicrcxeo.~ ive.s and should careful!)' consider and monitor the 

effects of any approved exceptio1-s or 

~A$U$01Sblllisguidance. th41ct~CII"botrdol 

ditGd.cWt"isuscdeo tt!« klthtrn~mbc«cdl.be 

1»ud of dilecku ~·ho lti\'t! pritu.-y rupomibUity 

!Of OTmeein& \he ~K~MC \"$CD;pe.'ISollia:l ;Sysklll. 

Dtpcod:~oat?.n~:JM:!nwhk.\tbebcDidi£ 

«p:~iud,l}it~u:».'fr(4:J41tt(l'l:.irt~ d¢( 

dir$ClOIS. a eotnpea~at!en coma:uce ollllo.bowd. o:aootberCOClmliUMolth.boudtblt bt: piiiW)' 

rt.!po:asibiti;ybto.\·m.tticgtheiucftltive 

eo~r.~f)'Siti::"LI~ll:eetH~oi'~'tiOs.UM!ttrn 

lef<n1o~~t.mdo ~~1!6:ilMilim's 

U~'iap!foll.kim.c..onAs!Ml~lhe~liO''.tJ\'etiU 

rorpoA~cii0013ar.agt~ttdatNmtl'l\; 

adjuslments on tho bala11oo of the 

arrangement, the risk-taking incentives of the senior executive. and the sa ret~ 

and .~u dness of the organization. 

The board of directors of •• organit.ation also is ultimately 

respcnsible for ensuring lhat tho 

organization's inoontive oo:-npensation 

arrangerntnts for all CO\Iered employees 

are appropriately bolanced ond do n01 joopardizathe safety and soundn.., of the organization. The im·oh·c-menl of 

the board of dire<tors in ov.,ight or the organization's ovan1ll intentive 

compansation program should be scaled appropriately to the scope and preV211!nce of the OLg.tni:zation's 

incenth•e compensation arrangements. Wrge l:cnhllg orgonizot~ttS ond 

organizations thai ore significonl u.rets 

of inc<nlive compenrolion. The board oi directors of an LBO or other banking 

organization tho! uses incenti'e 

compensation lo a significant extent should actively o,·ersee the 

development and operation of the organization's i.ne<:ntivc compensation polici8S, systems, •od n~ ated control processes. The board of directors of such an OJga 1i~tion should review and approve the overall goa~ and purposes 

o{theorganitati('ln's incantive compensation SJ"'entln addition, the board should pro\lidt!eleardil'tldion to 

management 10 ensure lhat the goals and polkJe.~ it establishes are carried 

out in a mo.Mct that ch e~as halan('..e and is consistent with safety and 

soundn..,. The board of director> of such an 

organization clsoshould cnswo that steps are taken so that the incentive 

r.ompensation system-including 

perfonnance measures and targets-is 

dasigned and operated in a manner that will .achieve balance. • The board of direciOIS should monitor the performance, and regulart)' 

reviO\v the design and function, of int.e.ntive OO:ttpensation arrangements. To allow for infonned revie\\'5, the board should receive data and analysis 

ftom management or other soW"'8S that are sufficient to allow the board lo 

assoss wh<lher tho o, . .,..n de>ign and 

pcrfonnancc of tho organization's 

incc.nlive corr.pen~Lion arrangements are consistent with the OJS3nization's 

safety and so.undn~. These reviews and repons should bo appropriately 

scoped to refloct the~" and complexity ofthe banking 

org:;miulion·s acli~·ities and the 

prevalence and scope of it.s incentive compensation arrangements. T~e board of dire<lors of a banking 

organization should closely monitor incentive compensation pa;1nents 10 

oonior cxfJtulii'IIS and tho S8~iti1•ity of 

those payn:l!nls to risk outcomes. In 

addition, if the compensation 

amngement for a senior executh·e 

induda.~ a cla.wback provisio!l, then the review should includl! sufficient 

inronna1ion to determine if the provision has been triggered and 

excculod as planned. 

The board or directors of a bonking 

orgoni23tion should mk to stay ab,..st of significant emergingcb;m~ in 

oornpcnsation plan mc:ch4ni.'ims and 

incentives in the marketplace as well as developments in academic research and rtgulatory advico regarding incentive 

compensation policies. However, the 

board should recogniu that 

organizatioi\S, adivities, and practices within the lndustry are not identical. 

Jncenti..,e compensation ammgeme.1lls et 

one organization may not be suitable for 

usc at another organization because of 

differences in the risks, controls, 

structure, and management among organlzalions. Tho board of directors or each orsanization is responsible- for ensuring thai the incentivl! 

compensation arrangements for its organization do not enr.ouraga 

emplo)·ees lo take risks the! are beyond the organi7.ation's ability to manage 

effectively, regard loss of the practices 

emplo)·ed by other orgoniutions. 

/..orge bonking orgoniwlions and 

orgoniznlitms I hal art .signifioonl users 

of inanlh·e rompensorion. 'rho board or au LBO or other o~ganiUttion that uses 

incenti..,e compensation to a sig.oiftcant c.xtcnt .should receive and review, on an 

aJmual or more frequent basis, an assessment by management, with 

appropriate input iroll\ risk· managemttll personnel, of the 

effe<tiven.., of the d.,ign and operation of the organization's incenth·e 

compensation system io pro\•iding risk· taking incentives !hat are consistent 

with theorgani7..ation'ssaJ4:ty and .soundnBSS. These reports .should 

include an evaluation of 'Yhethcr or hOIV inccnth•B compcmsalion practices 

may trea~e the potential for imprudent ri~k-taking. 

The board of such an orgoni23tion also •hould rec:eiva periodic reports thai 

review incentive compe:n~tion awards alld pa)'ments relative to risk outcomes 

on • bach•ard·looking bas~ to delcnnino \\'hcthcr the organization ·s 

incentive compensalion ammgements may be promoting imprudent risktaking. Boards of directors of th""' organizations also should consider periodically obtaining and reviewing 

simulation analysi.lof <X>mptnsation on 

a fon•ard·looking basis based on a ""8< of per!omtance !e~o·els, risk outcomes, 

and UlC amount of ri~kz taken. 
91 


71718219.eps

Federal Regisltr/Vol. 7$, No. 1:12/Friday, june 25, 2010/NOI.ices 36413 

• The o:pnization, compositio-n. and 

resou:n:es olthe boanl of directors 

should ptrmilefleclivo oversight of incenlive compensalion. Tho boanl of directors of a ban king 

organization should bave, or hava 

access to, a level or expertise and ex.perien<:e in ri!k·management and 

compen.saUon practices in the fin~mclal 

.servioos induscry that is appropriate for the nature, .scope, and comp!cxily of the 

erpnizotioo's octivitics. This IC\'CI of 

uportlse "">'be J'IO'"tlt Ollleetively 

'Mill lhc ,...,bas ollha boanl, may 

""""!tom r.m.llrainioa"' froo> 

.......... Hdra<siag lMse issues. io<ludi~~&asadireclor,ot~~aybe 

liumed throt:gll advic:o ...,.;...t &om 

CMIUide counsel, Oll!l$ulwus, or olber 

t):perts with txpertise in incentiV't 

comptnll~OO and risk·managemenl The board of dinclors of an 

CMS~Diution with less conrp!ex aod extensive incentive compensation 

tur.~ngements ma)' not find it necessary or llppropdate to require 5pecial board 

expertise or to ratain a.nd u.se outside exports in thts area. In .seloctinx and using outside parties, 

tho board ol direcWs should giv• duo lllcnlion 10 potential conflicts of 

inloresl ulsiag lmm other cholings ol 

lha patti• "il•th• "'&'Diutioa Of fur 

""'"' ........ 11le board abo shc>uld t:C~c:at:lioa IDI\"oid tf~icg 

0111S!da parties 10 obuio ll!lduole• .. ls of 

inAUIIICI. While lilt .-uon and use or ouulde parties moy ba helpfd, the 

boa.-.! 111aina ullimote re>poosibility fo: 

eMUiing !hOI tho Cll&aniution's inctnth·t compensation arnnsements 

"" consblenl ~<ith safety aod 

soundnass. L.otgc bonking orgonizolions ot.ld 

Of'80tti1Ations lhot oro dgnifiCGnt users 

of iiiCI!niivetomp<nsoiion.if a soparolO 

c:ompon~tion committee i.s not a 1rsady In ploooor required by olher 

outhoritios.•tho board ol directors ol 1ft LBO or other banking mganizalion that u.sa inctnli\'e compenSZition to a 

~ exl&otshould COIISidt< Oll>blb!ri~~&slldr a oommiueo-

...,..W.lo !be full boanl-lllal 1m 

p.'im»y respoasibilily lo< ....-lag 

lhurra;ni%1tioo's iacenli• .. 

comp1010tion 'Y"'""· A Ootnp<ll$llion commi:too should be """posod solely or predominantly of non-executive 

ditiCIOrs. If lha board does notba<e .surh a compensation cornmillee, tha 

board should lab other $lops lo ensure 

I hal non .. xoeutive directors of the boon! aructivoly in.ol.-td in lheoversighl of 

•s.-.,t~ewYcrt~otktuhl:tseLl.s.\o:t eo.,..,,.....,_ ...... ,")~OI4o( 

u,u,.~a.5GOS:dktn:~•"'*'-.~eCcdcstetkll 

•ut•IIIIU.~IIlloll. 

iueentiY& c:nmpensation sy$lems. 1'hs 

compenAtion connnitt• shCM:IId work. <l..,.ly •<ilh any boanl·lovol risk and audil commiUOC5 where thc3ubslanoo 

or their acllons ···etlap. t A banking orgllniz(ltion's disclosure 

pra<lico.,hould ' "PPM safo and sound 

incentive compensation arrangements. If a bankin, o~niution's inctn\i\'8 

compensalion arnnc<mcnu provide 

employoes incentives 10 lake risks that 

"" be)·ond tho tol....,ce ollho 

organiutiorl'uhmbolders.tht!l risks ore lil:tly 10 also pNMtl rUk 10 lha .. r..ymd...,.._oflha 

Olpitllioor." To ho!p proDIOie sallly 

md ...,.dnto$. • burkins ocguizalion 

slrCMIId """''de 1D opproprillo amc""'' of information c:onC*nin& its iactntive 

compansatioa ""'"'""""" for exenlive and nOtHXte\IU\'1 employees 

and n>latocl risl:·wnqemanl, oonlrol, 

and gov<rnane. proctS!O!IO 

shareholders lO tllow them to mnnitor and, where appropriate, take actions to 

restrain tho potenlial for such 

amlllgemcnls and protc.<S0$10 

on<:c>u11go employoeslo lake imprudcol 

risks. Such disc:losucos &hould include information re.lt\'allt to t:nployee:s other 

than senior txtculh'OI. Tho scopund 

level olthelo!OIINlion dlsc:losed by lhe 

"'l'ftlution •hoold be uilored to lho 

narunand toc~~plarly ollha 

ocplutioao:rd IUilctllti1 .. 

t.otr.~ioaamnaanents.n 

• Llcll bonlJaaCIIIplllutiooss!rould 

follow a s)'SiltDitk app-'r 1o 

devtlopilla a compansallo:l J)stemlbat 

hAs bal.ancocllncenth·e compensation 

amn~ents. 

All>anklng mganiulions "ilh ~ 

numbm or risk·IOklng employees ensaged In di\rerse tctivilies, an ad hoc 

approach 10 developing balanced 

li!Tilngomenl• ~unlikely 10 be reliable. 

Thus. an LBO should""" a syslemllic appr ........... upported by robusland 

formalized policlos, procedwos, and SJSiems-lo IIIS\IJ'IIIullhose 

'"'"""""'"' are appropriately baluted lftd coas1Jtonl1vith safdy 111d 

'"'""'"..._ Suc:b an approach slrould 

pro>iclo lor !be orpaiDtioa clb:ti..ly 

lo: 

' blartilyarpiQ}OIIwbore 

e!tp'blalo recai•·olnconth~ 

conapw;ation nd whoM ac:ttviti.e:s may 

~ ... :d. .. -.ted~y. CMI~'Iam.-w.slll.atmii11Mw..&s: 

t!U..W.-cbol-.tla'-~.,UUiionM 

1101 rc....nt, coull.cH w'lll$.1fdly81'1d 

... "Abtnt~Ot~lrMIGI& - tod!OdkScomply 

r.ri'111rthtlr.ar:lll'fCOIM~tltlrdl"JdoQif'CI 

ltqllfrM~CtUoltbeFtdtul_.,..•kw•r.dDtk 

lt.uu&pplltllb:a.S..,q.,l'foxyiX.tdowre 

Eft~AU.Sf'.C~~OS.lHOI8.34-

611?J.74 f'RIW4 (l)lc. U.IIOOiltlot.(I)Cbrotd 

olllOIIrklltooollttl. 

expose lhemganiuticn 10 NIOI1al risks. ThSS~emp o)·eesohould iocludo 

(i)seniorexeatlivcsand others "'ho 1ro 

""J))nsiblc for ovcrsi&hlcf lho 

organization•s firm-wide acllvllil$ or 

malcrial bu.slnesslinO!; (iii indl,ldual 

employeas. including non-oxccutivo 

employees, whose acliYilies mf.y cxposo lhe organiution to material amnunts of 

risl:; and (iii) groups ol employ,..•liro 

""subjoct 10 lhe samo or •lmilar 

inamti\'t compensatio.1 atTaft&eMtnLS 

ond «ho, iolho '88''11'10. "">' axposo 

lhc ocpintion to II'.>IINIIIIIOWIIS of 

nu: 

o ldcotily lhtlypes aile! tiroc horizoos cl ri!l:s lo lha arp:ritllion 

froi!lthe adi•ilies ol llroso employ• 0 A.ssessllltpole:rliallo<l!ra 

pu!ormaaoe rueasURS included in lha incer.li~r·ecompcn.s;ltion amngeme.nts 

ro. lhese employ«s to tn<OUJaSO tho 

cmploy...,to llkt impnrdenl ri!kl; n Include balancing elenrents. such ., risk adjustments or d.rernl perio<ls. 

\\'ithin the incentivacomperuation 

amnpeniS forth..., employees I hal 

ate twOnabl)• designed 10 """'"thai 

tho arnr.g""'cnt will be balanced in light of the sizo.lypo, ond limo horiUIII 

ol lhe inbennl ri!b ol lha cmployeos' acti\"ities; 

o CommuniC:Uelo lhCimp!cr)'ealha 

•'3)-si:l\'l'b:chtheirinc:entive 

-pensotioo ....w. ... P"l .... "u .. m 

bead;.:.r.diOrtflectlhtriJUollhoir 

odivities IO lhe orpoiutiorl; md ~ Monitor incentin compen.$3.tion 

award., pa)'ll'e:rls, risks raklt\, and riJ: oulc:oroes r .. lhesa tmploycos and 

modify lhe ret.vaatem""""eniS if 

payments made are nolappropriarely sensitive t<J risk. and risk. outcomes. 

m. Conclusion 

Banl;Jng organizatiOn$ art responsible 

fO!' ensuri113 that their incenlh•e 

c:ompe!IS3tioa arrangemenlJ do nol 

.ncoumge improdont ri$k·Uking behaYior and are consistent with the 

safety and soundness o! the 

mgaoiuliorl. The Agemies oxpecl 

bankir>3 "'l'ftiuliooslo lako p<o<r~pl 

odion Ill acldttss defrdeodes Ia their 

iDcer..ti\11 ampemttion arrucem-ts or 

nblad nu·-.nrent. CMIJal. md 

rn:-"~diOacl wtl mooitoc lhe odions lakan by ~ranLns O!&""izations in this area and will promole further advanc.,ln des lacing 

and implemeatlng balanced lncenllvo compensation aw«ngcmlllnt:i. Wllt>m 

appropriale, dro Agencies wllltako supervisory orenron:ement action 10 ensure that material dt ncleneies that 

pose a1hrea11o lhosafory and 

soundness of the organization aro 

promplly addressod. The Agancieul10 
92 


71718220.eps

36414 Fedenl R!lister/Vol. 75. 1\'o. 122/Friday, June 25, 2010/Nolices 

will opd.tte this guid>nce zs appn>priale 

to incorporate boot pr.~cti"" as tb.ey 

dmlop over time. Thu concludes the toxt of the 

Culdanco on Sound lnconti" 

Comptnsation Policies. 

U.ted:fune 17,2010. 

ja.lmC. Ou1on, 

O>mpirolll ... {tlMOmoncy. 

Dy onlorolt~o Boardof(lm:mOtS oltho 

Fodoralil<lon~ $p.tn:1, J'"e 21.2010. 

lobtrld<v.rn..-

Oof"''TS«moryoftb.Scotd. 

DUd:f ... 21.:1010. 

Valwlt~Bcst, ---,.Ft4nJ 

Drpod-~ 

Oo:od: fw:.t tO, 2010. Byd>e00ioooft1a:il50porv'......_ 

J~ft£.8oWIIIIft, 

A«I~~&OilfiC1or. 

I~Doe.aoi0..1So43$fiW6-*tO:~a.'ll.l 

-~COO( 411~W U tWU Utul-' &1»-

.... 

GENERAL SERVICES 

ADUINISTRATION 

1-2011).@;~ 1 

Federal Trnel Regulttion (FTR); Directions lor Reporting Other Than 

Cooc!H:Iass Aa:ornmcldotions lor 

~on OlfJCiol Travel 

AGENCY: Office of Co.....,..twtcle 

Polley, Ceooer.il Services Administr.ltion 

(CSA~ 

ACTIOK: 1\otico of GSA Bulletin fiR IDO.S. 

Suw.tARY: ·n.e C.neral Services Adn1ininralion (GSA}, in r.onjunc:lion 

with the Government Accountability 

Office (CAO) report, Premium cr~ss 

TrvveJ: lnremol Control Weaknesses 

CovtrnmeMwide Led to lmprope-tond A bum~ Use of hemium Oass Tlot'tl 

(CA~1 1268), has issued CSA 

Bullllin PTIIIG-40. This bullttiJI 

piOYides <lirecliocs to Fed!<al AS""cies 

1\w rtpOIIiDa otJJ. thon ex>acll-dass 

ICCOIDmodatlooslar 001ployoos on 

ofliciollrl•-.1. CSA Bulletin PTII IIHI5 moybolounclat hltp1h.--.p~pl 

ftdero/t,...~ln:gulation. 

OATtS: The provisions in lhis Bnltatin 

ore •lfocti•·• Juno 9. 2010. 

FOil f\!RTHU II~ORIIATIOII Off!ACT: Mr. 

P~trick O'Grady, om., of 

Covernmon111;de Policy (M), Omce ol Tr.ll'el. 1'11nsportatlon, and Assot . lfanagemont (MT), Genet31 Services 

Adntlni!lntion at (202) 208-1493 or vi.1 

e.o10il at potrick~dJ~go<' Pleose 

cite GSA Bull~tin PTIIID-«>. 

Dlltcl:Jv.nt!&.2.010. 

lkdyRhodtr, 

Amcf<lroAdmlnOttGIQ{, O{{KeofTro .. t, 

Ttonsponorlon.cttd M$tl MonoJtmtnl. 

tfl Occ.1Gl0..1SW FIW ... l4• 1l\t;.4S to] 

811.lflGtoct:ct20-tW 

DEPARTMENT OF HEALTH AND 

HUMAN SERVICES 

Indian Huhll Service 

Amerieorllndionolnto Psychology; 

NOiice ol CootpeOOw Grant 

ApjllicetionsiOt A110ricen lnolOIISinto Psydlology PlllgrJ111 

AMOU:w:rmtnfl)J>r.~ew. 

Funding Opponunity Number. HHSIHS-2011)-INPSY-<1001. 

CFDA Numbtr. 93.970. 

Key Oates 

Appli<oti<tt IA:odliiiC:)uly 23,2010. ncview Date: July 29.2010. 

l:iorlksf Atllicipoted Sto~ Date: Sepltruber 1, 2010. 

I. Fund ins Opportunity Oeocription 

Tltelndian HOI!th Smoice OHS) is 

accepting compelitit·e graot applicetions f« llle Americon lodions into 

PS)'tilolCCY l'n>pa. This p<Cpl is ••thorized ur.derthea.lborityo£"25 c.s.c. 16llp(a-d)",lndl.ao Heohll Cue 

l~t Ad, Public l.aw94-'37, 

as •-clc<l by Publ:c Law tOz-573 &Dd Public Lawl\t-148. 

PutpOSl 

The purpose of tho Indians inlo 

PsycholOGY Propm is lo dovtlop and 

maintain Indian J»)'fhOIOS)' Ql~ 

r&r.nJitmenl prngro~ •~ a met~n$ nf encouraging lndil:ms to enterths 

bohaviotll health field. Th~ program Is 

dosalbed II 93.970 in thoCatologof Federtl Domoxtie M!~tance. Cos:s wi!l be determined In 1000rdance ~-ith 

applicable Offico of Ma~~~&tmMtlnd 

8ud$tl Circular$. The Public Health Seni<o (PHS) ls co:omllleclto achieving lho health [IIODiolion ond disout 

pm-eatloo tlljocliva ol Healtlly Peoplo 

2010,1 f'KS.led adi•ity fer sollio& 

priorityareas.'!\isp<opm 

aMoouu:cmentls related to tbo priority 

artt ofEduati~l4nd Community· based p!Oj;ram~ Potential applicants 

may obtain acopyofH,.Ithy People 

2010, .umrnary mpo<l in print, Stock No. Ot1-()()HlOS4?-8, or via Cll-R0:-.4, 

SlnckNo. tO?-()Qt-()QS49-S, through 

tho Superintendent of Documents. Govenunent Printing Office~ P.O. Box 

371954, Pittsburgh, PA IS2S0-7945, 

(202)5tt-11!00. Youmayai>Ooocess 

this fnfont~allon viltho Internet a!lho 

lollowing Wtb site: hnp:ll 

'"'"-~eollh.pl/heohhypeople. The PHS M>ngly encoura,c:as ollllJllnt and contract recipients In provide 1 

smoke-froc "orkplacoond promoto tho non·u,. of all tobacco products.tn addition. Public Law I03-227,tho Pto0\ildren tlct of 1994. prohibits smoking in certain facilities (or in some ~ses, 

any portion of tho facility) in which 

reguwor routine cdu~Jlion,library, 

d>y care, healTh cam, Ot early childhood 

dcl-elopment wvices ut prorided lo children. This is oonsl>!eot with tho 

PHS nrissioa to protectood od•~ocolho 

pllysicel and .....UI heott~oflho 

Aroeriaa poopl& 

D. Award lnformatioo 

1)pe of An~tds: Cntot. f.<timaled Funds A\'oilohJe:Thototol 

•mount identified lot Fiscal Year 20t0 

l5Sm.l86. Thoa,.~rd is for 12 months 

in duration and the average award h 

<Jpproximately S'252,462. Awnrd.s under 

this announcement ara subiect to the availability of funds. In the abs<ncc of 

funding, the agtncy is under no 

obligation to make 01v.ards hmded under this announcement. 

Anti<ipoted Number of A11nnU: An 

estimaled tt<O av.·ards .. ;ll be •""• under the p«lSRm.lf lundi.'13 ~ 

ll'lilable. additionola .. .,ds ,.., be 

made. 

Projea Ptriod: 4 

Awtmi Amount:~n. po<,...... 

!H. Eligibilay Information 

1. Eligible Applioonts 

.. ~:~~:1u:':~~~t;·~:.~~i~es clinical prognms accredited by the American Psychological A!SOCialion 

ll'ill bo eligible to apply foro grant under this anuounct~mont. ltowevcr, 

only one grant ,~lJ be ••·arded and 

funded to • college or unh·mity per fundingcyclt. 

z. Cost ShDringli.lolchinf 

This a:>r.O\Illcement d ... not require 

IIII!Chi11g fuods or cosl shorifl&. 

3. Ql.htt Roqui.....,DIS 

R!quiredAffiliatio~111tpt 

applicant must submit ofticill documenlotioa indi~Jtina a Tribe's cooperation with and support oltbo program within the schools on its 

reservation and its willingne.~s to haVIO :a Tribal representa.ti\·e ~i"S on tl1e prognm advisory board. Documentation 

must be in d•e fonn plllSCribed by the 

Tr;be'sgovemingbody. i.e .. lenerof support or Tribal resolution . Documentation musl be submitted from 

•V<IJ' Tribe in.·olvcd in the IV'"' 

program. llapplicaliOll budgcls ClCOCd 
93 


71718221.eps

..... 

..... 

BOARD OF GOVERNORS OF THE FEDERAL RESERYE SYSTEM 
94 


71718222.eps

...... 

Incentive Compensation Practices: 

A Report on the Horizontal Review 

of Practices at Large Banking 

Organizations 

October 2011 

BOARD OF GOVERNORS OF THE FEDERAL RESERYE SYSTEM 
95 


71718223.eps

To order additional copies of this or other Fooeral Reser\'e Board public.tion& ron tact: 

Publications Fulfillment 

Mail Stop N-127 

llo:trd of Go\'ernors of the Federal Resmc S)~tcm 

Washington. DC lOiS I 

(ph) 202-452-3145 

(f") 201-71S-SSS6 

(e-mail) Publications-BOG@'rb.gol' 

This and other federal Reserve Board reports are also a"ailable onlint at 

IIIIW.ftlicraltNn~go,iboarddocslrptcooyt>~defaull.h!m. 
96 


71718224.eps

iii 

Executive Summary ................................................................................................................. 1 

Steps Taken by Firms .................................................................................................................. I 

Scope and Status of Reform Effort ... .. .... .... .............. .... .................. ..... . .... ............. ... 3 

Introduction ............................................................................................................................... s 

Pre-Crisis Conditions and Response ............................................................................................ 5 

Risk· Based Adjustments to Compensation ................................................................................ 5 

Principles of the Interagency Guidance and Supervisory 

Expectations .............................................................................................................................. 9 

Affected Bank Persomnel: Executive and Non-Executive Employees ............................................. 9 

Four Methods for Linking Compensation and Risk ................................................... .................. 9 

Avoiding "One.Size F~s-AI " Lim~s 0< Formulas ............................................ .. ................ 10 

Well-Designed Manageme11tandControl Functions .................................................................... 10 

Timelines fO< Adoption .............................................................................................................. 10 

Incentive Compensation Horizontal Review ..... _ ............................... 11 

Scope of the Horizontal Review and feedback Provided ........ .. .......................... II 

Balancing Incentives at Large Banking Organizations .............................................. 13 

Topic 1: Risk Adjustment and Pertormance Measures .................................... .. ...................... 13 

Topic 2: Deferred Incentive CO<npensation .... ..................... .. ... 15 

Topic 3: Other Methods that Promote Balanced Risk-Taking Incentives .......... .. ...................... 17 

Topic 4: Covered Employees ..................................................................................................... IS 

Risk Management, Controls. and Corporate Governance ......... .. ... 21 

Topic 5: Risk-Managemeflt and Control Personnel and the Design of lncenlive 

Arrangements .......... ....... .... .......... ... ... 21 

Topic 6: lnce11tive Compensation Anangernents for Staff in Risk-Management and Control 

Roles ... .......... ........................... .. ... 22 

Topic 7: Practices Promoting Reliability ......... 23 

Topic 8: Strong Corpcrate Governance ... 23 

international Context .............................................. .. ConfO<manCe with Interagency Guidance . .. .................... . . ... 25 

..... 25 

European Union Ajlproach to Deferred Incentive Compensation ................................................ 25 

Conclusion ................................................................................................................................ 21 
97 


71718225.eps

Risk-taking inccntir~ pro,idt-d by inccnti1~ rompen· 

sation arrangements in the- financial services industl)' 

"''"' a contributing factor to the financial cri~s that 

began in 2007. To addr..s such prae1i<es, the Federal 

Reser~~ first proposed guidance on incen1i1~ rom· 

pensation in 2009that ~'adopted by all of the fed· 

eral banking agenci~ in J .. ne 2010. 

To fost<r implementation of improved practi~ in 

late 2009 the Federal ReserYe initiated a multi· 

disciplinary. horizontal review of inctnti\'erompensation praeli«s at 2) large. rom pi~' banking organi· 

latio ~ 1 One goal of this hori!ontal revie-v "~s to 

help fill out our understanding of the range of iru.~nti\'e compensation practires across !inns and catego· 

riesof employees within firm< The second. more 

imponant goal"~' to guide each fimo in implement· 

ing the interagency guidan«. 

Giwn tilt varie~y of activit ~at these complex firml. 

and tilt number and range of employees "no are in a 

position to asswnc significant risl<, our approach has 

been to require each firm I<> dC\·clop. under our 

superYision. its own practices and gO\-emance mechanisms to ensure ris~-appro-priate inctnlht compensation that aorords "ith the interagency guidancc 

throughout the organilation. Supenisors assess<'<l 

areas of weakness at the finns.. in response to "hkh 

the firms ha1~ de1~lopod c()mprehensi'~ plans out lin· 

ing ho11' those weaknesses "ill be addressed. These 

plans as modified bas..'<! on comments from supervi· 

1 ~lifKll).ialillSlilu!i<msiD lOC lnm'lli\'e Compms;uioo Hori. tonta! R.c\i-..'3rt 1\lly Fi~nciallnc.: A~ri"ln E.'pn-ssCom1\'11\)~ Bank of Anm"3 Corpor.uior.: The Blnk of Nt'fo' York 

M..tlon Corpora1ion; Capiro.! Qn.: F"m;mciatCOfJX!ration; aligrooplnc-.: Di.{('O'o'tffitUncial SM~TbcGoedm3nSlcbs; 

Group. 1,._-.:JPMorp.n Chast &: Co.: Mo.pnS1anl')~ NonJl. 

tro Trw Corpor.nion: The PSC F"IJllllcial St-1'\i:\.~ Croop. lnc.:S.ale Suctt Corpor.nioo: S~mlnN Blnl:s. loc,: U.S. B.:ln· 

oorp; :md Wclls fa~'O& ComJ"'n)~ and lhc U.S.op:ralionsof 

&srdl)'$ pk. P Parib.t,(. Credit Sui~ Group A(i.!A'tl~~ 

ll3nk AG.IISOC Holdings pi<. RO)III Blot of CaiD<b. Th: 

RO)>ItbnkofSro<JandG""'pplc.S..'i.1C~3nd 

UBSAG. 

sors, will be the basis for funher progress and 

e''aluation. 

As explained in more detail in this repon. every finn 

in the re1iew has made pi'O"JCSS during the reviC\v in 

dc1tloping practi~ and procedures that will inter· 

naliu the principles in tht interagency $uidance into 

the management S)~tems in each finn. Many of these 

changes are already Cl;dent in the actual rompcnsa· 

tion arrangements of finns. For example. senior 

executires now hlll~ more than 60 pcn:cnt of their 

inccnthuompensation deferred on M·erage, higher 

than illustratirc intemational guid<lin01 agrt'Cd by 

the Financial Stability Board. and some of the most 

senior exocutil'es ha1·e more than SO pen:ent defenred 

11ith additional stoc.k retention requirements after 

defem.-d stock 1-csts. Mo"-owr. fim>S are now atten· 

tire to risk-tal<ing inccnth-cs for large numbers of 

employoos below the cxecutil< le\'el-at many firms 

thousands or tens of thousands of employeeswhich "-as not the case before the beginning of the 

horizontal reriew. 111lcn most firms paid little ancn· 

tion to risk·taking incxntires. or were anc.nti\'C on~' 

for the top employees. 

Yet '"''Y firm also needs to do more. As Ol'crsight of 

inctntil'erompensation mov01 into the regular super· 

l'isory process. the Froeral eser~~ will continue to 

11urk to ensure progress rontinu01 both in the implementation of the firms' plans and in the risk· 

appropriate charae1er of ae1nal compensation 

praCiices. 

Steps Taken by Firms 

With the oversight of the Federal Reseman<l other 

banking a~><nci~ the firms in the horilontal rel'iew 

haw implemented new practictS to make employcts' 

inccnth·e compensation sensiti\'e 10 risk. The fol1ow· 

ing is a brief progr..s repon on four key areas of the 

reviC\1'. More details can be found in the report: 
98 


71718226.eps

lnctntire Com~n~tion PractittS 

• Effe<lirelocenli•·e Compens:uioo Design. All firms 

in I he horizonlal wiell" ha•·e implcmemoo new 

prn<tires 10 balaoo: risk and financial resulls in a 

manner that does not enooumgeemployees lo 

expose their organizations to imprudem risk& The 

most widely used methods for doing so are risk 

adjustment of a.mrds aod defertal of paymen1~ 

- Risk atljusrmems make the amoun1 of an in«n· 

ti\'ecompensalion all"ard for an employee lake 

in1o accoumthe risk the employee's acti\'itics 

may pose 10 I he organization. At the beginning 

of the horizolllal re\'iew. no firm had a "<II· 

de•·eloped s1r.negy to use risk adjus1mems and 

many had nocm:cti\'e risk adjust ent~ E•<ry 

firm has made progress in de\'cloping appropri· 

ate risk adjuslments. but most h.r.e more work 

10 do to ensure the full range of risks are appropriately balan<td. An e.ample of a leading·edge 

practice thai is now u;OO by a few fim>s is includ· 

ing in int('rnal profit measures used in in~nti\'e 

compensation a.• ards~ charge for liquidity risk 

that takes into account stressed condition• This 

reduces incentil·es to take imprudent liquidity 

risk. 1\n example of a challenge for many firms 

is da<lopmcnt of pol[cics and pro<tdures to 

guide judgmental adju.stments of in«nti•~ com· 

pensation a•>rd< Such internal guidelines help 

promote consistency and cft'ectho-eness in inetnti\'t compensation decisionmaking. 

- Deforriug payout of a portion of incenti\'t compensation ""~rds can help promote prudent 

ioo:nti\'es if done in a •~Y that takes into 

account risk taking. especially bad outcomes 

Deferring payouiS ·~• fairly common before the 

crisi& especially for senior ,.eutil~ and highly 

paid employm Howe:.·er. pre-<risis deferral 

arrangements typically "~re not Slruttun.'\llo 

fully take account of risk or aciUal outcomes 

Almost all finnsnow01sewhicles for some 

emp o)~ I hat adjust <lm•n•ard the amount of 

deferred ioo:mh·ecompensation that is paid if 

losses are large. ou-e-~r. most firms still hOlt 

work to do to implement such arrnngemcms for 

a larger set of emplo)= and to more closely 

link such reductions to indi•·idual employees' 

action~ particularly for cmplo}ees below the 

senior executi\'t levd. 

• Prog..ss in ldcnlif)·ing K()' Employees. At most 

large banking organi<:ation& thousands or tens of 

thousands of employees ha>~ a hand in risk taking. 

Yet. before the cri~& tbe co •~n ional wisdom at 

most lim1s was that risk-based incenti\'es were 

important only for a small number of senior or 

highly paid employees and no fim1 S)'Sien>aticall)• 

identifl«< the rele•~nt employees who could. either 

indi\'idually orasa group. influence risk. All firms 

in I he horizontal re•iew h:ll'e made progress in 

identifying the emp!Oyet$ for vohom incentirc com· 

pensation arrangements may, if not properly strue· 

tured. pose a threat to the organization's safet)' and 

soundness. All firms in I he horizontal re\'iew now 

recognize the importanre of establishing sound 

ince ti•~compensat on programs that do not 

encourage imprudent risk taking fort hose who can 

indi•idually afl'octthe risk profile of I he firm. In 

addition. slighlly more I han half of I he firms ha•·e 

idcntifl«< groups of similarl)•compensated employees whose combined actions may expose the orga· 

ni:zation 10 m:ut!ria\ amouniS or risk. HOW'C\'Cr. 

some finns are still working to identili' a complete 

set of mid-and km~r IC\ el employees and to fully 

assess the risks associated 11ith lheiractil'ities 

• Changing Ri k-~laoagement Processes and COiltrois- Because finns did not consider risk in the 

design of inrenth-e compensation arrangements 

before the erisi~ fim1s rarely in•·oh·ed risk· 

man;wment and control personnel when consider· 

ing and canying out inttnti'-e compensation 

arrangemont~ All fim1s in the horizontal n.'liew 

a1~ changed risk-managcm.,\1 processes and 

internal controls to reinforce and support the de~~

opment and maintenanre of balan<td ioo:ntire 

compensation arrnngemen1s. Risk-management 

and control personnel are engaged in the design 

and operation of inrenti,·e compensation arrangements or olhercmployces to ensure that risk is 

properlyconsidcn.'\1. Some firms ha•·e further work 

to do 10 prol'ide suflicicntly acti,·e and robust 

engagctnent by risk management and control statT. 

• Prog..ss in Altrring CorporJie Gorrrnaoce Fr•mrworks. At the outset of the horizontal rel'il:\v. the 

boards of dirtttors of most finns had begun to 

considtr the relationship be:nretn incenti\'C C'Om· 

pcnsation and risk, though many ~~~refocused 

exclush-ely on I he inccnti\'e compensation or their 

~nn·s most seniore.xetuti\"es. Since then. all firms 

in the horizontal re•iew hOI~ made proo.ress in 

altering their corporate gowroance frameworks to 

be auentil·e to risk·taking inccntiws cn."atoo by the 

inrenti•·ecompensation process foremployees 

throughout the firm. The role of boards of directors in ioo:nti•<compensation has ''panded. as 

has the amount of risk information prorided to 

boards "'Ia too to ioo:ntil·e compensation. The 
99 


71718227.eps

appropriateness of the degJtt of engagement of 

the boarrls will bee\'aluated aOer a few l'"'" of 

experience. 

Scope and Status of Reform Effort 

Supel\isors in the horizonlal rc·view gathcrt-d wnfi. 

dential supel\·isory infomtation from all firms and 

lound important diiTereoces in practices a<ross bU>i· 

ness lines and banking organizations. Additionally. 

practices are changing rapidly in r<>ponse to the Fa!· 

era! ResenT's e!Tons and industry de,·elopments. 

Thmrore. a moment-in-time. romparatiw anal)>is of 

indi1idual firms from the horizontal revi<IA is not 

possibk and rould he misleadiog. That said. the Fed· 

m1 Rcsene is wonting to foster market dilcipfult in 

the area of inttntil~ rompensation. On this front. the 

October 2011 

Federal RcseM intends to impkment the Basel 

Committee's recent ~llar J di><:losurt rt'(Juirements 

for remuneration.'' iS>ued in July 201 1.

1 which will 

provide mort romplctc infonnation about riskrelated ekmcnts of ineentil~ rompen~1 ion practices 

of indhidual institutions. 

In pan spurred by the horiiontal m i¢'1•. ineenti,·c 

rompensation practictS at b.10king organizations are 

rontinuing to Clohe and <klelop. We ''pect this evolution torontinue. The F«..cral Rc,ci\C •·ill rontinue 

to"ork •ith these firms through the supel\iSOI) 

proct» to el\lurt imp101emcnt and progrt'SS are 

sU>tainoo. 

= S.<t•Pll:ttJcb.iowA:rtqGI~\tll~nr:T'hlll~"'J ~ 

lbrbd('-t«."Wfw --~t•n 

~'pl~"'l-~ 
100 


71718228.eps

Risk-taking inccntir~ pro,idt-d by inccnti'~ rompen· 

sation arrangements in 1he- financial services industl)' 

"''"'a contributing factor to the financial cri~s that 

began in 2007. To addr..s such prae1i<es, the Federal 

Reser~~ first proposed guidance on incenti'~ rom· 

pensation in 2009that ~'adopted by all of the fed· 

eral banking agenci~ in J .. ne 2010. In 2009. the Fed· 

eral Reserve announced a horizontal review of inccn· 

ti,·e compcnsalion practices at a group of arg~ 

complex banking organization..\ (See "Principles of 

the lntera.,otnC) Guidance and Supef\isory 

E>pectations"" on pagc9 and ··lnccntht Compcnsa· 

tion Horizontal Review" on page II.) 

Pre-Crisis Conditions and Response 

As discussed in the intera~cy guidance, the aclivi· 

ties of employe.s may cmue a wide range of risks for 

a banking organization. such ascn..'dit. market. 

liquidit)'. operational. kgal, romplianct, and reputa· 

tiona! risk~ as ""U as h~r risks to the \'iability or 

operation of the organization. Some of these risks 

may be realized in the short term. while others may 

become apparent only owr the long term. For 

example. future n..·wnues that are booked as current 

income may not mat riali~ and shon-tcrm profit· 

and-loss measures may not appropriately reflect dif· 

ferences in the risks associated "ith the m·enue 

derived from difl'erent acti,ities. In addition. some 

risks-¢r combinations of risky strategies and positions- may hare a low probability of being realized 

but would ha-'C highly ad,'Crsc efl'ects on the organi· 

zation if they were to be realized ("bad tail risks"). 

While shareholders may hare less inccntire to guard 

against bad 1ail risks beeaose of the infrequency of 

their realiza1ion and the existence of 1he federal 

safety net.lhese risks warrant special auention for 

safety-and-soundness reasons giwn the threat 1hey 

pose to the orgaoization·ssolrencyand thefederal 

safely net. 

Before the crisis. large banking organizations did not 

pay adequalcaucmion 10 ri>k \\'hen designing and 

operating their inccnli\"e compensation systems. and 

some employees"~"' pro>ided incenti\ts to take 

imprudent risks. For example, an emplo)~ who 

made a high-risk loan may have generated more rev-

'''"' in the short run than one 1rho made a low-risk 

loan. lnccnti,·erompensation arrangements bast-d 

sokly on the e,~l of shon-term m-enue paid more to 

theemplO)\'t laking more risk.thtreby inctnti\iting 

emptoyees to take more. sometimes imprudent. risk. 

Led by supeovisors in the horizontal rel'iew, O\~r the 

past two years banking organizations ha\'c impro\'ed 

their inccnti,·e compensation arrangements to take 

appropriate acrount of risk. Thet\\O most common 

"~) S to do so-risk adjustments and deferral- make 

use of risk infom~at n that becomes a-~ilable at different points in time. 

Risk-Based Adjustments to 

Compensation 

Information about risks taken that is known before 

inctnlil'erompensation is 3\\~rded can be used to 

make risk adjustments to those 3\\~rds. For example. 

if an cmp O)~'e in a lending unit makes many high· 

risk loans during a )~ar. the estimated profit from the 

loans can be adjusted when designing theemployre's 

inctnth-e compensation package. using either quanti· 

tath·e or qualitatire information. In all cases. risk 

adjuStments should consider likely losses under 

stressed conditions. and not merely bu~ness-as-usual, 

so that larger, butlower-probability.loss outcomes 

can be taken into account. 

Both quantitati\~ a11d qualitati\'e risk information 

can be used in makingsoch adjust men" They can be 

applied either lhrough use of a formula or through 

the exercise of judgment and may pia)' a role in set· 

ting amountS of inccnti\~ compensation pools 

(bonus pools). in allocating pools to indi\iduals' 

incenli,·e compensation. or both. The ell'ecti,~ness of 

the difl'ercnt types of adju~ ents ies with the 

situation of the employee and the banking organization, as "ttl as the thoroughness of 1hcir implcmcn· 
101 


71718229.eps

lnctntire Com~n~tion PractittS 

tat ion. Banking organizations in the horizontal 

review hal"e maddgnificant progress in improving 

their risk adjustment~ but most still ha~'e work to do. 

The first topic in "Balancing lncenti1e, at Large 

Banking Organizations" on page 13 descri~ the 

main types of risk adjustments and some areas in 

which funher work is needed.' 

Ddcm:d incentil"tCOmpcnsation can contribute 10 

pmdent ioomtil'eS becauso risk taking and risk out· 

comes often become dC'3rer O\'er time. If pa)'OUI of a 

~nion of inoonti'-e compensation a'"'-ards is deferred 

for a period or time after the a11~rd date.late·arril"ing 

information about risk taking and outcomes of such 

risk taking can be used to alter the payouts in "'l~ 

that will impnwe the balaru:e of risk ·taking im"tn· 

th-es. Banking o~-ran zat ons in the horizontal re\'iew 

ha1·e made progress in improving deferral practices. 

but many still hal"e work to do on pcrformaoce con· 

ditions for \\'Sting. Deferral practices aredescribc<l in 

the second topic in ··Balancing lnccnti\\~ at La~~! 

Banking Organizations" on page 15. 

Risk adjustments and deferral are not the only 1111)~ 

of improYing the balance of risk-taking incentil"c& 

Some altematires. such as the use of longer pcrfor· 

manee periods when emluating employees· pcrfor· 

mance and awards and reducing the S<nsitilityof 

a11~rds to measures of sho.rt·tcrm perfom1ance are 

brieOy dcscribc<l in the third topic in ··Balancing 

lnC~:nti1t> at U.rgc B.1nking Organil.1tions" on 

page 17. 

Atlhc beginning of 1he horizontal review. the con· 

\'CntionaJ \'isdom at most firms was that risk-taking 

incenth·es were important <mly for a small number of 

senior or highl)' paid emplo)= Though the deci· 

sions and incentires or seniorexceuti1·es are indeed 

1·cry imponant. the combined risk taking by a group 

of similarly compensated employees can also be 

material to the fim1"s risk profile. Thu.~ identif)ing 

the set of employ«~. who may individually or collcc· 

tirely expose the firm lo material amounts of risk. is 

a key dement of practice. The interagency guidance 

notes that such ""coven.'<! employees"" should include 

not only those who can indi1•idually aft"ec1the risk 

profile of the firm. but also groups of ~milarlycom· 

pcnsated employees 111lose actions when taken 

together can affect the risk profile. Examples of such 

groups rna)' include many types of traders and loan 

originators. Most finns in the horizomal re1•iew have 

1 Emplo)'l.\".i: SOtJ')Clinxs: lak ri~ io pul)U:il or~ Olhtt lb311 

~11-tcrm finJorial rcrfonml'lX.Ia such ca._~ ri5k adj®· 

ments lllJ~ oJoo oontribtltc to blblll\'d rilt-IJl:ing oo.'llti\\'~ 

made progress in identifying coren.'<l emplo)\'CS but 

some still ha1~ 111>tk to do. The founh lopic in "Bal· 

ancing lncentiles at Large Banking Organi1.ations" 

on page IS discusses co1~red employees and progress 

in identifying them. 

As described in the interagency guidance. establish· 

ment of prudcm risk-laking incentives should be 

critically supported by risk-management and control 

personnel. In addition. practices to promo1e 

impro1~11lell!S in the reliability aud effectiveness of 

inrentiw: compensation S)'Stems 0\"'Cr time can usefully suppon dc,<lopment of prudent risk-taking 

incenth·cs on a sustained basis. These elements are 

described in ··Risk ~lanagement. Control>. and Cor· 

porat< GowmanC\l·· on pagc21. 111lieh notes prog· 

ress in most areas.. 

Some obserwrs a1~ been panicularly interested in 

comparing progress of incenth~ compensation ptac. 

ticesof firms hcadquanen.'<i in dincrent jurisdictions. 

Approximately one-lhird of the large banking orga· 

ni1.ations included in the horizontal re~·iew are h<ad· 

quanered out~de the United States (foreign banking 

organ zation~ or FBOs). In general. progres> in con· 

forming to the interagency guidance is similar at the 

U.S. banking organi1.ations and at the FBOs in the 

horizontal review. and progn"SS in conforming to the 

Financial Stability Board"s (FSB) Prilrciples for 

Sound COmJ!f1151JiiOn Practim(Principles) and the 

related fmplemRnUtti{)lr Srmulords.

4 which are somewhat less demanding than the interagency guidance. 

is also similar. asdescribc<l in "International 

Context" on page 25. 

As the horizontal revie-w of incenti\'t compensation 

practices draws to a close. further \\.'OTk on incenli\·e 

compensation will continue through the normal 

supcrviSO'J' process. Much supervisory work is 

already focuS<d on risk managt~ncnt and control S)'S· 

tems. Risk-laking ineentil'eSare a complementary 

focus for supervisors. Howe\'er, incenth-e compensa.· 

tion practices are likdy to CYolve rapidly 01~r the 

next sewral years. so both firms and supcrYisors 

must continue to adapt and improre. The Federal 

~rw also intends to implement the Basel Commit· 

tee·s n.'eent '"Pillar 3 diS<Iosure requirement:. for 

remuneration." issued in July 2011. lncrcaS<d public 

diselosure about risk-related incentil~ compensation 

pmctim at major fim1s may improre market disci· 

• Th¢ F$8 i§Ued !he ftit:<ipks i11 Aprill009 3JKI the Imp/~ 

Mi<m St.aWrJJinStp~crY~bff 2009. Tbtsr FSBdocutn.."'''bl rt' :r.<tibbk aa"'",...r~atH1it1boaAJ .• t.if~_ 

publ>;liiO«l>tdJl.\"lll<l.~ hun. 
102 


71718230.eps

plinc of such prncti«i. Finally, I he Fedcrnl RcscrYC is 

working ~ilh Olhcr oonking and financial regulaiOI)' 

agencies to de\•elopan intc-raget'IC)' rule on incenti\'C 

Oc1ober 2QII 

compcnsa1ion pracliCl'l. as mandmed by 1he Oodd· 

Frank Wall Sure! Reform and Consumer Pro1ec1ion 

Acl (Dodd-Frnnk Acl). 
103 


71718231.eps

-·--·· 

Principles of the Interagency Guidance and 

Supervisory Expectations 1 + 

The intcrageney guidan<-.: is anchored by thn.-.: princip~: 

I. Balance betlll'tn risks and r.sults. lncenti1~ compensation arrangements should balance risk and 

financial results in a manner that does not 

encourage cmplo)"C\'S to expose their organizations to imprudent risks; 

2. PrO<t'SSI'S and controls lhalrrinforcc balan<c. A 

banking organization's risk-management processes and internal con1rols should reinforce and 

suppon the dmlopmeill and maintenance or 

balanC\'d in<:tntil'ecompensation arrangements: and 

3. Effecti,·ccorporatc go,~nance. Banking organizations should a1~ strong and cO"cct l~ corporate 

gown1ance to help ensure sound incenti\"e com· 

pensation practices. including acti1·e and effect ire 

owrsight by the board of director.;_ 

The interagcney guidance iseonsistent 11ith both the 

FSB Principii'S and lmpltmentarian Sromlards 

adopted in 2009.1 

Afi"ected Bank Personnel: Executive 

and Non-Executive Employees 

lncenti\'"C compensation arrmngemems for t.\:t'Cuth'l! 

and non-cxecutil'e<mployces able to control or influenre risk taking at a banking orsanization may pose 

safety-and-soundness risks if not properly struc-

' On April t4.))ll.asnuod3!«lbylh< Dodd·fi'WA«.Ih< 

Fol<r.ll R"'o~ ~ •ilh tii<Ofl"«olti>:Cornp<roli<rolll>< 

Cum.·ncy. the Fro.."''3l IXpoo;.il IBSUr.lOO: Corporation. the rormcr Ol'fK"C" of Thrift ~J:'""fu.lbl: Natiooal C~t Unioo 

Admini){nl!ioo.. tl\;: Slxuritks.and b.ilang.! Commi$$.ion.. 3nd 1~ Ftdcral HoWns Fin.tr~Ct A~'\'flC').l'Sucd for oocnmcn1 a proposOO Nkoo i~\-n1ilt rompa~~ioo rract~ The prop>5«1 ruk build~ otT lbc nL~'Q.SCflj,)' guidan«. Th~ rc~ 

l"«us:cson the: obsmatiorLS from1bcl\orizootal mkv.. \\ftirb 

11.35 ('(K'll.h.l•.'t«l iB lhc (WI(t\L o( t)): inlcQgo.-ncy p.~id3..r!lx :.J"'.. 

doo.."$tl()ldi$CUS$1htpt'()fl05tdlll~~~ru~isao.'3il· 

abkaL n'll~,(..by;.,,;~fR·2011-M-IJ~fr.OII·~31 

p.lf. 

tured. Aocordingly. the interagency guidance applies 

to senior cxecutill'S as ·~II as other employ«S who. 

either individually or as pan of a group of similarly 

compensated employees. hare the ability to e'pose 

the banking organization to material amounts of 

risk. In identifying employees ro1~red by the interagency guidance, banking orsanizations are directed 

to consider the full range of inherent risks associated 

with an employee's work acti~ ies.. rather than just 

the Jerel or t)1JC of risk that may remain after application of the organization"s internal eontrols for 

managing risk ('"residual risk'} 

Four Methods for Linking 

Compensation and Risk 

The interagency guidance discusses four methO<Is 

that banking organizations often use to make in<entil~ compensation more sensitire to risk: (I) risk· 

adjusting incenti\'C compensation awards basz.."d on 

measurements of risk: (2) deferring payment of 

a•~rds using mechanisms that allow for actual '"~rd 

payouts 10 be adjusted as risks arc realized or become 

better known: (3) using long.:r performance periods 

(for e.>ample. more than one year) when emluating 

employees' performance and granting a•~rds; and 

(4) reducing the sensitivity of a•~rds to measun-s of 

shon-tcrm pcrfom~a >ce. • Each method has ad,~

tages and disadvantages. 

A key premise of the interagency guidance is that the 

methods used to achie~-eappropriately risk-sensiti1·c 

incenth·eeompensation arrangements likely will differ across and within fi rm~ Employees" activities and 

the risksassociated 11ith those actilities vary ~gn fieantly across banking organizations and potentially 

across employees 11·ithin a panicular banking organization. DiOerenees across firms may be baS<.'<! on 

their principal chosen Jines of business and the char-

• AsDMcdintl'le'inl~f'agl.'tX')' tJidaOO:.Ibislislofm.eth~istiOl 

intto<kdlobenha.US1h-e -otbcrmethods~r.Us.lorbc 

d..c>!oped. 

_L 

' I 
104 


71718232.eps

10 lncenti,·c Compensation Practices 

actcristics of the m1rkets in •·hich they operat~ 

among othtr factors, lfll'Cting both the t ypcs of risk 

faced by the firm and the time horizon of thoseris.h 

E\t:n within fim1S.. employees' acthities and the 

attendant risks can depend on mauydiR'erent vari· 

abies. including the specifiC sales targe1s or business 

strategies and the natu"' and deg"" of control or 

influence that diRe"''" employees may hal'e 01-.r risk 

taking. These diOerences naturnllycrcate diR'erent 

opportunities and diO'erent potential incentii'C.S. 

broadly speaking. for cmp!oyees to take or influence 

risk. Thu~ the use of any single. formulak approach 

to incentil~ compensation by banking organizations 

or superl'isors is unlikely to be elfectil'e at addressing 

all incentives to take imprudent rish 

Avoiding "One-Size-Fits-All" Limits 

or Formulas 

The interagency guidan<-e ltelps to al'oid the potential 

hazards or unintended conS<.'quences that would be 

associat«l with rigid, one-size-fits-all superl'isory 

limits or formula< Subject to supervisol)' 01~rsight . 

each organization is respon~ble for ensuring that its 

incenti\'C compensation arrangements arc consisaent 

11ith its safety and soundness. Methods for 1chic-•ing 

b.-'lla c.\~ inctrllirecompcnsation arrangements at 

one organization may not be eiT'ec:th-e at another 

o~anizat n. in part because of the importance of 

integraling incenti,·ecompensation arnmgcrnen1s 

wi1h 1he firm's own risk-management systems and 

business model. Similarly, the cfi'ccti•·cncss of mcth· 

ods is likei)' to diftcr across business lines and units 

11ithin a large banking organization. In general. large 

banking organizations a"' likely to need multiple 

me1hods 1oensure that inocnli\'ecompensation 

arrangements do not encourage imprudent risk 

taking. 

Well-Designed Management and 

Control Functions 

The intmgenoy guidance ruso places grrat emphasis 

on the role of risk-managem<nt and internal control 

functions in pr01iding for balanced risk-taking inctn· 

tii'CS. Poorly designed or implemented incentilt compensation arrangcmcn1scan thcmsel\'l'S be a source 

of risk to banking organirutions and undermine 

existing control~ For example. unbalanced inctntil'e 

compensation arrangements can place substantial 

strain on the risk-management and inlernaJ control 

funaions of C\'en well-managed organizations. 

Therefore. risk-manng.:ment and internal control 

functions should be inl'oi,·oo in designing. imple· 

mc:n1ing. and evalua1ing irte"emivt compe-nsation 

arrJngemcnts to ensure that the arra g?~nents prop. 

erly take risk into account. 

The interagency guidance l'lwgnizes that large bank· 

ing organizations tend to be signir.rant users of 

incenti\'eoompensation arrangements,. and I hat 

ft311W approaches to incen1i1t compensation at these 

institutions are more likely to haveadwrseeR'ects on 

the broader financial St~te . Accordingly. the inter· 

agency guidance elaborates with gn.-ater sp."Cificity 

cenain supervisorye.tpectations for large banking 

organizations. 7 

Timelines for Adoption 

In adopting the interagen~y guidance. lhe banking 

a.oencies recoguiz«lthat achie1ingconfonnance 11ith 

its terms and principles would likely require signifi. 

cant changes and enhancements 10 lirm practices and 

that fully implcm<nting such changes would requi"' 

some tim<. For the large banking organizations in the 

horizontal re'iew. \\t communiCi'Ued our expcclalion 

that e<~ h firm should demonstrate significant prog· 

ress loward consistency wilh I he interagency guid· 

ance in 2010. should achie ~ substantial conformanco 

11ith the interagency guidance by the end of lOll 

(aR'ecting the award of incentirecompensation 

a•~r s for the 2011 performance ym). and should 

fully conform tbe.,afier. 

' Fore.'tampk. t~ n1cra~ p!idaoo·S13!estbat b~ b3nklng 

org.anil<Uion:s~ba\'(aS)'S!ttnalirc~Pf>CC3Chtoitlcttlti'c 

(OO)pt:ns:;lionsuPJ)Ort<db) formalilcdaOOt~o'ci!-<lc\Tk>propoti· 

~ pr\\.'\'durc\ and ~)')t<m$ to oo~rc 1M. ~'\'tlti\..:<omJ'(a.(;J· 

lionarrani~-111C!liS.att'~tct) lxllar..'\'daodC'OilSislrnt 

\\ilhsafct)'and SO\Irxi!XSi s~.~~.t insl~ution:s~uklalso b.:J'I.'C 

rot..bt (lrl).'l."dun."$ foe colk\.'ti~ infoti'!Ulion aboutlbc dTC\'U of t"'-iriM'fllh-ccomp.'ltSJtion programs.on«n(llo)~ri:!l; laking. 3$ \\\il 3:S *'Siems 3nd prlX'.'&.""'"S for u.;ing this inf001)3tiofl to 

adjust COI'Ilp.."0..'31ioo arr3ns~'TIX'lns tocfimiMtr or !\"duct unirl· 

tm.kdi/K\-nml$ ror risk taking. SimiL1~.d~e iat~1· 

JUidanct lll\,'\':1 b~~ banting OJl3n!atioM 10 3(11\~· monitOr 

indll$lr). ac:tdnnk . .and regul:norydndopmrnl5 in int..'\-ntht 

('(lmp."ll5oltionpr.tcti~:J.nd t~ 3nd~prcpal\"dtoiocofJ»' 

r.ue into lhcir i~K"mti\'( ('()Q't(!Ms.tlioa S~')l.ans o..'\\' Of ~ng 

mcthods.tlut ~re lil:dy to impnl'l.~ !b:: Otpnilalioc'J'sloog-ttrm 

(lll3ncial-.'dl-00in,g.and ..::Jfety 1nd ~ndot$. 
105 


71718233.eps

In late 2009. in conjunction 11ith its initial proposal 

of principles-baS<(! guidance on inC~:ntil~ compensation,the Federal R<S<rw launched a spocial simultaneous. horizonlalw·iew of incenth·ecompensation 

prncti<es and related risk management. internal con· 

trol~ and corporate gorcmance practices at a group 

of larst complex banking Of!"nizations. These firms 

rmcchosen b«ause n:~rwtl appro.1Ches 10 inC~:ntir~ 

compensation attht:SC instilutions are more likely 10 

har~ adrerse etTerts on the broader financial S)~tem 

and b«ause of their C.\tensiw use of incentirtcom· 

pensation pmctict$. The si)-'Cial work associated with 

the horizontal review i,s now nearing completion, but 

supervisory work on inceMirecompensation rrill 

continue through the ong<>ing supef\·isory process. 

The Federal Resem has communicated to the firms 

our assessment of their practices and ourexpocta· 

tions for remediation in areas "'here impro\'cmtnts 

are needed. The fin11~ with the or~rsight and input 

of the Federal Resef\'C. have each dcr~ op<-d remediation plans. These remediation plaos. along with 

updates and discuS>ion around them, h:~r·e betn a key 

mt(hanism for bringing clarity about needed 

changes. 

Scope of the Horizontal Review and 

Feedback Provided 

To carry out this majorsupervisory initiatir\\ the 

Federnl Reser\~ made a substantial commitment of 

stan· resources and senior management attention. 

Mor< than 150 indiriduals from the Federal Resent 

and the other b.1nking age11cies h:~r·e betn inrolwd in 

the horizontal review. In addition to senior superrisory stan~ these included a multidisciplinary group of 

professional~ includingsupef\isor.< economists and 

la"~-ers. st~·eraJ spociallyoonstituted inecntir~ rom· 

p¢nsation on-site rt\'iew teams. and the permanent 

supe"iso!)•tcams aS>igneclto each of the invohoo 

banking organization& Federal Resef\·e stan· has 

coordinated with other banking r<gulators in con· 

ducting the horizontal reriew and communicating 

with the firms. 

II 

To perform the superrisory aS>CS>ments of conformance with the interag<ncy guidance, 1r~ gathered 

extensi"e information from the fim1son their incentil'e compensation arransements and associated pro· 

cesscs. policies. and proo.'dures We rer·iewed internal 

documents go,eming existing ino:-nth-e compensa· 

tion practices as wdl as sclf-assessmtms of incenth'C 

compensation prJctiCl'S relatir~ to the interagency 

guidance. We rondu<ted many face-to-face -tings 

rrith senior e,,C(utire ofiicers and members of bo.uds 

of din.'<:tors' rompen~11ion ronutti11ces. To supplement this information and 10 er~luate spocifically 

how inrenti\'e rompcns:uion programs were implemented at the line-of-business kvel. the Federal 

Reserve conducted focused exa ination~ of incenth-e 

compe'nsation practices in trading and mortgagtorigination business lines at a number of the organizations inroh\"<< in the horizontal rc\iew. 

The Federal es<"~ has continued to pror;de individualized feedback to each of the firms as additional information and updates of remediation plans 

hm been rmhoo. All of the firms har~ made prog· 

ress toward achieving consistency with the interagency guidanre. Titc natur< and extent of rrmaining 

work \'aries across organizations and sometimes 

rrithin organization~ Achie~ ing confomtancc with 

the interagenty guidance depends on the snce<:ssful 

build-out of >)'stems and prOC\'lSCS. achiewment or 

intermediate implementation milestonL"S. and success· 

ful completion of rrrnediation plan• Er·en then. in 

many cast$. it 1rill be important fort he fimlSto keep 

in mind that new systems and practires ha,·e not been 

fully tested by experience. so ongoing monitoring of 

these new S)~tcms and prae1ire; 11ill be important. 

With regard 10 FBOs with activities in the United 

States,~~~ h:~r~ acknowledgt-d the particular challenges that ariseasthey seek to conform their US 

opcrotions 11·ith the details of their home-country 
106 


71718234.eps

12 lncenti,·c Compensation Practices. 

consolidated regulalor'sc.<p<(lalions and 1hoscof 

1hc in1eragency guidanre As no1ed.1he imcragcncy 

guidance is consistent with intemational regulatory 

efforts on iocentirecompensation practices. including 

lhe FSB PriJ1riplrsand lmplem<"llation Stamkmls. 

We a1~indieued our imen11o lollo11·1hecomplcmenial)' principles of cO'eclil~ consolidated supervi· 

sion and nalionalU\'almenl of banking organi1,;11ions 

opcraling in lhe Uniled S1a1es. s 

1 forobstr•arion~ regardislg i~~nthTromprnslliorl prlll.'tim 31 

FOOi. Sl.~ -lnltm..,LlO!IJIC'oo!"C-"( on pa~ 2). 
107 


71718235.eps

This section describe> met~ods firms u:;c to pro1ide 

employto.'S "ith prudent risk-taking in<enth-cs, as"'" 

as idcntifll'S the rele1ant set of employ"" It is mostly 

related to the forst of the three principles in the interagency guidance. 

lncenth·e compensation arrangements achie\-e bal· 

an<e bel wren risk and financial ""'~rd \\ilen the 

amount of money ultimately n.>ttiwd by an employee 

depends not only on the employee's performance. but 

also on the risks taken in achie\ing this performanre. 

Firms ofien dctennine the dollar amount of inrenti,·e compensation "''•rds for a pcrfonnance year 

immediately afier the end of the year. Pan of the 

a\\ard may be paid immediately and pan may be 

defem'<l. Risk adjustments (S<O Topic I below) are 

features of incenti\'e compensation arrangements 

that incorporate information about risks taken into 

decisions about the total amount of '"~rds. Deferred 

payouts can also be adjusted for risk using information that becomes a1ailable during the deferml 

period. as dcscrib-'<1 under Topic 2. Topic 3 focuses 

on other balancing method& and Topic 4 on identification of co1~red employees (those employ~ for 

whom prudent risk-taking ineenti1~ are panicularly 

imponam). 

Topic I: Risk Adjustment and 

Performance Measures 

At the beginning of the hc>rizontal review. no firm 

had a \\tll-<leveloped strutegy to use risk adjustments 

and many had noefl'cctive risk adjustment~ Currently. all finns in the horizontal review employ some 

son of risk adjustment for at least some subset of 

employees. but the role of risk adjustments in the 

01~rall mix of balancing st mt~~es 1-aries across fim1s 

and across businesses within fon\\~ Some adjust· 

mcnts ~I)' on quantitati\'C mea.sui\'S of risk, while 

others are based on pcrce~tions of risks taken by 

employees or business units. Quantitatire measures 

of risk may be applied mechanically(although this is 

rdathtl)' unusual) or as an elemtnt in judgm~nt· 

13 

based de<:isions. Risk adjustments may play a role in 

setting amounts of bonus pool~ in allocating pools 

to indi,;duals' in<enti1-ecompensation, or both. In all 

cases. risk adjustments should consider likely losses 

under stressed conditions. and not merely bu~ness· 

as-u>ual. so that larger. but lower-probability loss 

outcomes can innuen~ inO!nti\'es 10 take risk. 

E1~1)' fim1 has made progress in dmloping and 

implementing appropriate risk adjustments. butt he 

progress is une~-en, not only across firms. but 11ithin 

finns. Substantial work remains: to be done to 

achieve consistency and eO'ccti1·eness of such adjust· 

ments in prol'iding balanced risk-taking ineentire& 

lkcausc most inctnti,·ecompensation de<:isions 

im·oh-e some judgment, a key element of that work is 

impro1w written policies and procedures and 

impro,·ed monitoring pmctices. 

Disciplined, Judgment-Based 

Decisionmaking 

Judgment is an ekment of decisionmaking at CI'CT)' 

firm and at nearly cwry step in the design and opera· 

tion of inrenti\'C: compensation arrangements. 9 This 

poses tll<l challenges: (I) ensuring that deci~ons 

based on judgment are made consistently can be dif· 

ficult and (2) risk adjustments may be only one of 

many inputs into decisionmaking about inctnti'-e 

compr!>sation a11-ards. Without appropriate restmint. 

judgments about other aspects of an employe''' performance. soch as achiel'inga certain lel'el of market 

share. could be made in a ""Y that ""uld undermine 

the desired inecntii'C efl'ccts of the risk adjustments. 

To promote consistency and eflil<th·eness of the 

impact of judgment on balan<~.'<l risk-taking i""'n· 

ti1~ the interagency guidan<e notes that firms are 

expected to hal'e robust policies and procedures to 

guide the consistent usc of judgment. and that deci· 

sionsshould be documented so that flrmsean re1i<w 

~ An e;.;~i® is fonnlllak I;OOI~'TIS:.Utoo pbn~ such as rom!Jlis. ~<3l.",$~~1,1ihith$00)Z1~sp..'\i(~ lml)tJDISofir'k.\'fltr.~ 

coolp."tl53tion:k\wdiagtoa sp."\"ir~eformubS~:tllt thebe-gin· 

niogoftht'~\"Jr. 
108 


71718236.eps

I~ lnctnti\e Compensation l'raelict:. 

~ htlhn poli<i<> and prottdurts ,,. bring folio\\«< 

and C3n ,,.,.,. the etfe<ti\<ntSS of th~ poli<i<> •nd 

pr'OC(dures O\~r time.10 

At the bq;inning of the horizontal I'C\'kw. most firms 

lacked ~rittcn policies and prooxlur<S to guide m>n· 

agm in making risk adjustments. and policks and 

prottdur<S for inctntne compensation ckcisionmak· 

ins often did not deally identify the~~ to b< 

P'tn 10 rbl;s tal:m duri"! the ptrfonnanct )tar. 

Sudl policies and prooxlum. a!on' -ith uaimng for 

man~er> and t.t fi'JSI ,..;.,. of d<ci,ion' arr impor· 

tan! to achie\ ing con~•ten 1 applk>tion of risk 

adjustllll'nts. Some firms h :n·e mack progress in 

dmloping" riucn policies and prooxlure,and 

rrlatcd p= but others,,. still in the process of 

completing this work. 11 

Quantitative and Qualitative Risk 

Measures 

In 1.':1\<'S \\Mre ri>k adju;untntS are applied based on 

a formula. i!K'tnlirc compensation dt"('bions ;u'l! 

made u~ing measures of li11ancial perrormancc I hat 

are net of a risk charge based on a quantitnth·e meas· 

ure of ri<k. Such adjustments balanct inc:cnthos to 

take ri,k 10 the extent that such charges oiTsct 

incttalC> in financial ptrformanct(or reductions in 

C'OSI!) that a~< associated \\ith inmased rill. l4kt11J. 

Tht US( of mcdoanical ri>t adjtbunmb i; J10»1b1c 

"'htn suitablt quantitatn~ rill. mta>U~<~ ,,. :1\>il· 

abk. ond the etfttth'tii<SS of this t)'J'C of ri>k adjust· 

mcnt depends on the quality of the ri>k mc:bure. One 

leading edge practice. obserwd at .ome firm, is to 

a>SCSS a charge against internal profit mca;un:, for 

1

• h.'ll' ('\lf!lrk,111 orp~~iwioo ,;book! hl\t l"'t.~ ud fiRX'O' 

d""tNI"""'bc""'-alt""'...Sto""""JUds· 

8JC'Q110Jdp(o.'t bDlrix, iDdadiiiJ I cJNrifUOI., ti •1fQ.C'I;tc4, o(tk_ .. _........,._oht......,.,, ""'""""'-""'100:-iiU..,IIIonor.l~ 

llml\.Wpob.-..-,.Uld~I(\'\J ... •oh~af'C't\'t'!i:' 

wl)><>tobcfoiloo<dio«-~-., ""'""l"''· ftftl'\ ~141ould f'CO'idcmo&.lfa st.~ 1m Kid llhtnlr.'tiOrlllul 

d<\WOMQnt-:ji.OOfiC'd:aOO~t~'\J ona<'k-u~con­

..;,,<111 b3~h ;m.J lho.'I'Cb) aJJOVo (« t'C poM 11)0fUioritiJ. 

II ~firm~h;r."tid«llift.."dinlflrit,.olri.."\ ilndrc"OI.'NU~'f'C" 

dr .. ·r~~IOI)~tclot~ liDrotbusiM\):tndnnplo)l'( 

rolc •• orliJdtngl\'fcrt1).~poiAh.,lObc «WW....J,."fC'db)maM$<'· 

Mrnl v.tnnW.in~~ risl.lllj\N.Mtnt' ~firm~ 

""' """"""",.... """'!'"""""""""'.mid • ~""'" d<"""""""" IN odjo;tm<at< and Jila<d • ,..,,..... do.'W· _ ..... """' .. _."';..o( .. tdo.-~ 

........ -.s-:-.:.Oimt""""'-- """"'"IOb.,., .. ~ ... .-.ro~o-""* 

""''~' ...... """ ............ ~"' Tbc)lolt ~ol""'""'"""""' to-oa.lm;lo)tnlbout holl. ri.J.:.Jj~W.m(al)~A"Oft.~AtlirntifN.ialto(ulim~1on 

n<t.uJ.,,.d<\'NQo<. 

liquidit) risk that takes onto account >tressed rondi· 

lions and 10 u.c th~ ad)U>t<d profit m<3SIIre in dettr· 

mining ineentiw compensation awards. 

Most firms in the horizont:Jl re' iew also used quanti· 

tati\'e risk measur<S as an input 10 judgmtnt·based 

inttnti\tcompensation d«i~ionrnaking. For 

eumple. boanh of dirte~Or> usual~· take into 

aCODIIIII3\aibbl< ri,J: ~when mal:ingckci· 

~about """"spool> for the firm or about..-.~nh 

for senior et«utno. Some ri<l measures ean bt dif. 

fteult to con-.n into quantitati\e risk cha~ but 

e.~nhelesscon"l' n.cful information. HO\\t\'Cr. as 

noted p~<' ously. achie>ing a consistent balancing 

impact throu ud ental d<cisionmaking is a chal· 

eng~ Firms with more dl.<fC\~Iopcd policies and 

proc:cdur<S to guide dcci,ionmakers in judgment:lll)' 

usingqll3ntitathe risk information scnned mol< 

likely to achine a roosistmt babocing impatt. This 

is an arta in •llicll ntafl) firms a1< ~orting to 

imprO\ceiT«th~ 

Almost all firn1> in the horizontru rc\·iew use non· 

quantitati,·e pcn:cptions of ri>k taking as a basis for 

some risk adju>tmcnt~ Such adjustments hare the 

potential to addi\'>S harli·to-mcasure risks and limi· 

tationsof exbting data and risk·measurementmeth· 

nd< For =mplt. the mana£<r of a lending business 

might be..-.~,. !hot $0111( nnployl'tl of the business 

make riskitr I<»D> and othtrs saftt loa~.,.., 

thoo~ the qll3ntitatn~ n,lmruures ;n-ailobk to the 

manager do not >hO\\ it. Based on th~ information. 

the manager could risk adjU>t by giving lower ine<n· 

th~ compensation ""rd> per unit of ,..·enue to the 

employees making the ri>kier loan< As in other cases 

whtre inc.:nti\'e contpcnsationa~,~rds are based on 

judgment·bascd deci~onmaking. they are more likely 

to be consistmt~· eiTttti'< "here firms h:n~ clear 

policies and prottdur<S 10 !"ide application. 0..<1· 

oping sadl policks and prooxlures i; particula~ 

challmgjns b«aw.e the information about risk is 

qualitati\t and the natul< of the information tend> to 

changeorertimc. 

Risk Adjustment and Bonus Pools 

lnc.:nthe compensation practkcs or firmsdiiTer in 

the proms of dt~trmining the total bonus pools and 

the allocation of incenthc compensation 10 indniduals. In a to...,.,. .. ~ smior mattag<m<~~und 

111< board of di~<e~or> dttnmine the size of an 0\er· 

all amount of fundinJ for the firm a; a ~itote near 

the end of the pcrformanc.: ) ear. and this bun us pool 

is then split into >ub-pooh for rnch business. Pools 
109 


71718237.eps

are allocated to indit idual otmployccs in a manntr 

related to their indi,idual pcrformaoce. In a 

bottom-up proces~ the finn assesses pcrfomtance of 

each employee and assigns him or her an inctnti\'e 

compensation 11 rd. with the total amount of inctn· 

tire compensation for the year for the fim1 as a whole 

simply being the sum of il>di,idual incentit~ compenS.1tion awards. Most firms' processes are a mixture or top-do1rn and bottom-up. but the<rnphasiscandiffer markedly. 12 

Risk adjustments balance inccntire compensation 

arrang<ments to the extent they affect the incenti1•.:s 

provided to indit idual~ The impact on incentires 

may be limited in cases wh<re a finn mak<:s risk 

adjustments onl)•whcn deciding amounts of pools 

because the 11~rd to each ~mp oyce under the pool 

,;n rective the same adjustment. This is appropriate 

when the nature and extent of risk taking of all 

employc.:s under the pool is the same, such as cases 

where a pool applies to a business unit in 111tioh all 

risk dceisionsareinfluell<\.'<l in the same "~l' by all 

employees. Where inditidual employe.s in a single 

pool can hare ricd et~ s of impact on the amount 

of risk, the difleren<>.>s 11ill not be fully address..'(! by 

risk adjustments to the pool alon~ In such cases. 

additional adjustments inoorporatcd into decisions 

about individual incentire compensation awards 

would be netdcd to make the risk adjuStment fully 

etT«ti\"e. 

Next Steps 

Most of the firms in the horizontal retiew h31·e made 

significant change-s to thci• risk adjustment practices 

for a11~rds for the 2011 perfomtanc. year. Still. most 

continue 10 have work to d.o, including de\'dopment 

of appropriate policies and procedures to guide judgmental adjustments of inrentitt compensation 

a11~rds. Most finns should continue to ct~luate the 

cffecti~tnessof the quantilatiw: and qualilati,·e ris.k 

adjustments they are u~ng and whether risks are 

appropri31ely balaneed. Additionally. in lll12 fonns 

should evaluate ho11· eft~ ire the risk adjustments 

used forthc 2011 3\t~rds were. and akei pro,~­

ments as nettSsary. The Fodera! Reserve will continue 

to work with I he fin11s lo make sure progn""SS com in-

•: E\m a~lirms \liltt a bouom·uptm~ b...Js--1 roRSttairm: 

pb~\' a pn..'"'li.:a! limit on lhc iii~ of the 3~1\);iltt booliS for 1~ 

lirmas:a"'OOk SO~Iop-d®'ftl'L.-mtnti),pttStrl.L$imibt!): 

topodo'l\n firms l:lh-som: :K\.'Ount of JICC'I.'ei\'C'd p:r!orma~oC 

l:ey indilidlllls in felt ins poole. 

<Xtober 2011 15 

uesand to evaluate best practices in this area as they 

C\'OIW. 

Topic 2: Deferred Incentive 

Compensation 

Another method for balaocing inccnti,·eoompensation arrangements is to defer the actual pa)lllll of a 

portion of an 3\ ~rd to an employee significantly 

beyond thcend of the perfomtanc. period. adjusting 

the payout for actual losses or other aspects of the 

employec·s performanec that are realized or become 

better known on~· during the deferral perind. Such 

deferral arrangements make it possible for the 

amouut ultimately paid to the employee to reflect 

infom atio~ about riJks taken that arrit~\luring the 

deferral perind. 

The interagency guidance does not require that deferral be used for all employees: does not suggest any 

specific formula for deferral arrangements: and does 

not mandate the usc of any specific rchicle for payment, such as stock. Ho11~w.the intcrageocy guidance does ha\"e some speciticsuggestions relating to 

deferral arrangements for senior executives. A substantial fraction of incentireoompensation a11~rds 

should be deferred for seniorexecutives of the firm 

because other methods of balancing risk-taking 

incentil'f.S are less likely to be effecti1~ by themselt'f.S 

for such indi,idual& 

Elements of Deferral Practices 

The proportion of incenth"C compensation a1,-ards to 

be defemd ~'substan ial at the fimts in the horizontal reriew. For example. senior executi\'es now 

31~ more than 60 perrent of their inccntil'ecompensation defem>d on 3\~rage. higher than illustrJti1·e 

intemational guidelines agreed by the FSB. and some 

of the most senior executit-es h31·e more than SO per· 

cent deferred 11ith additional stock retention require· 

mcnts after defemd Stock rest& Most firms assign 

deferral rates to employec-s using a ft<ed schedule or 

"cash/stock table" under ll'hich employ"" m:ei1ing 

higher incenti1~ compensation .,,~rds generally are 

subject to higher deferral rates. thoush deferral r.ues 

for the most seniore>ecutit·.:s are often set separate!)' 

and are higherthan those for other employees 

Deferral periods g<nerally range from three to fit·e 

yea!$. with three year> the most common. Most organizations in the horizontal Miew use the same deferr.tl period for all employees in a giltn inetntiltCOnt· 
110 


71718238.eps

16 lncenti,·c Compensation Practices 

pensation plan and often for all empiO)'l'tS. o~ 

firms tmnsfcrowmrship of the entire deferred award 

to the emplo)\'0 at theend of the \'OSting period 

f'clilr l"esting"). while others adopted a schedule 

under which a portion of the award l"estS at giren 

intervals. 

The most common ~hiclts for conl'eying deferred 

incenti,·c compensation to employees are shares of 

the firm's stock. stock optionund perfomtance 

units (an instrument wilh a payout \'alue that 

depends on a measure of perfomtance during the 

deferml period. often an accounting measure like 

earnings or retum.on.((!uit)'). Some firms usc 

dcfem.'<l cash or debt·likc i nstrumenl<. 

Performance-Based Deferral 

At the beginning of the horizontal review. few• firms 

adjusted payouts of deferr<'d awards for risk out· 

comes or other infom1ation about risks taken thai 

boca~ a1•ailable during th.c deferral period. Without 

such performance conditions. deferral arrangemen1s 

are unlikely to contribute to balancing risk·taking 

incentil'es (for ease of reference, deferral with perfor· 

~ conditions is refcm.-d 10 as ·-perfonnanrebased deferral")." 

n Tiloc:ommon tssucs 'llith pcr!ori'CI3o<\"-b.lio.-d 6.-ferQJ bo.'""JITIC 

Mrduritlgt~ ~tal rt\'i.-..: 'flit fitS!. is: fl.-bled to~·· 

mcnt ol dcfcrtc\J ina.'flti\c«~mp.-mation in sh3~·ro'Std inst.N· 

ITICnL.;.\ ~-tt\\.'biclc$.an:$hl~·ba-<i.-d.~1hrlillX'~r\'Sare 

il\l<ltdcd. ris.k·takingactio~during t~ ~rfotmal).'"t )~t migl'll 

ha'l'<' cil~r ups)& Of 00<;\·llOOc<'ffMs oo 1~ ~tot.-t prilx in Lhc 

rururc.sot~nctcll"mooim.,ti\tsis001d..w.Mor«<\t-r. 

IJK'IS.I<'1TI~'l\'S:bcio'a thc:scniort\<\'\lti\~le\\'iarenotlil:d) to 

tdico.'tlhatth..; oYonml:-Wint:&xi.~"U.l!lb'ta~cri:d 

irn.pad on the: lirm'sMock pria. forCMm(.kifthc lc'adrl'of a 

businomunit kiiC*'S I~I3!Xll1it:ulat strat~ rna)' k-Jd to~ 

tiUt ar.: 1.14,"'<' from the )taOOpoiot o( 1~ Ullil,thc k-ad« mat bdico.'t any s~il ~ wookl be 100~ t113.n oll's..'l by pro(Jts 

rrom Olhcr busi().""S t.1niL.t Thu-~ the ~'f would 001 (',,f\'\1 the 

~ to31l"IX'Iti'K- ultimatt ,'3Jueot d.:fcmd M' rl.'t\'i\\.\1. and 

dcl'tml woold h.:J\'t lillie' ir:npa .. 1 on his or"'-" risk-W.i~~g ln..\'11· 

ti\t$. In onkr for3d,:fcrnl ;unu~T!K'ntto rncatJiflgfull)•C'OQIn'ba~ to bllaore. '~.'Sting Lri£So--rs sbouJd b.: tlasc:d on mcast~n:s 

o(p!rfOITnaO«thataretird:«<ltotb:crnpiQ)w·$risk-takiQ.J 

a...'1i\i~ t"Spp.'i.lay t00sc Iilia bcfol'l: the iM."'''Ii\'t.{'l()tJIJ).."T\S3· 

tlonav.·:mL 

Th-9:1.-ond rornmon iNIC tll3t b«a.rrx-d:ar durin-g~ borilonlalfl...,ira' rda!N to 1hc r.u1-.'\lla.r p.~rondilions 

(trisgcrs)~'fl by firm;;. Some rums h.ro~ pcrfonnanc.'\.'-ba...:cd 

dcfcrr.d 3ff.lll!tm:tlb I bat all\w. (Of :1 b.~ Of OlJI~'\1 p;I)'OUI 

"'b'n the \~l.'i.'Softri~·r$ rdl..'\1 ~th't po."'fi'OnnliiiX. tiO'A'· 

C\'t ,th<-scarf3~'tll)r'ltl)'CI'ICOUrlS:ClTIMl\.'1tOtak:l."moct 

risk durin~ tbr: dcfm;tl p:riod.. in oni:r to ma.\"imU.c tt.: \,.JI.IC 

of)tt..ilt~£\3ndthli$Tni!)nolbili111.-.:-ri$1 tak.ingii'K\"ffti\c;;, 

On.:: wmpk of 1 tRuer thlt may~ appropriate-is oo: that 

rtduo.utbc:amol.llltofdcf\'fl\'d(;om~'fl~iootltalis,~cdif 

tb:firm(or bu.)il'lt$$ til\:' or unit, dtp.."'''diBgon thtlC\~ of tbt 

tmplo).x)c-.\p.'limc6 ~Lh-e nct incom: in :.n) fiS~.-al )ttr 

during till cJortrrnJ J>IOOO. l'b.l n.ol.,lllt tri_~~ f<lr afl)' 

Firms in the horizontal "'''it'll' ha1-e made progress in 

impkmenting performance-bas..'\! deferral armnge· 

menls I hat promote balanced ris}Haking inccnti\'es., 

E>ch firm's setup is some111tat different. but thm: 

broad styles of armngement were ob;erved- formu· 

laic.judgment·bascd. and a hybrid of the two. In a 

formulaic approach, the perrentage of theaword that 

rests is din.'<tly related to a measure of performance 

during the deferral period. In a jud~nt-based 

arrangement. the circumstances under 111tieh less 

than full 1-esting 11ill octur are decided judgmentally 

ruther than being linked to fixed 1'alues of perfor· 

mance mctrics.. and the amount of inctnti\'e compensation paid out under those tircumstaneos is also 

decided through a jud~nt based proces.<. In a 

hybrid setup. a specific trigger ~lue of performance 

is set at the beginning of the deferral period. and if 

perfonnance falls below that trigger valu~ a 

judgment-based process determines how much of the 

defem.'d incenti,·eoompensation 11ill not rest." To 

the extent that judgment pia)~ a role in the \'<Sting 

decision. firms aree.xpeetcd to ha1'\l robust policies 

and proce<lures to guide the consistent usc of judg· 

ment, and decisions should be appropriately documented so that firms can monitor ~e et er their poli· 

cies and procedures are being follo1red." Policios and 

procedun.-s noed to be clear to employ~ or they will 

not a~~ a dear understand in~ when risk·taking deci· 

sions are made of which outc~mes will l""d to forfei· 

ture. in \\1lich case deferral arrangements are not 

likely to have a significant impact on risk-taking 

beh:ll·ior. Many fimrs still hlllt work to do on their 

policies and procedun.-s in this area. 

Most firms in the horizontal rt~iew haredawback 

arrangements for at least some employees that are 

triggered by malfeasance- violations of the firm's 

policies. and material restatement of financial 

result~" Such dawbaek pro,·isionsean contribute to 

l''"""""''·bcl.«<l d<f<ml ""flt"'l"' >!so $11oo~ bo •'l">ri) c.~pJaincd to em~~ C'O\'m"d b)•thost armn~'t'I'ICDL-.. 

~ In al"Q!!llf1011\'3ri3nlof\JI(-~'bridp~on;.'\:tlw.:-tri,~r~ 

mct fora particulirt:f\XIp(e.g.. abusitlffiul'lit).tbe~iofl. 

:\1) pro(.~ Qct('mlin('S. DOl 00~ tbc p:rt\'1113~ ot iJ]('I.'Il(i\1: 

('(lmp:n$3lioRthat \61-\ but Jllo\\ilidl tmplo)\~;).I'I:SLI~'1 

IO Je-ss than (ulJ \'CSI[ng_ ~ualJ) ba9.'d 00 'Uotl .. il c-mr.4o)"\'\":S 'A 'CCC 

rCSJIOn.<lit* for b.~ or rOf imprudent rk,l: taking. 

u Col).~msabout tbt u:st or diSI.-rttion in ck(crr.ll arT3Jl~'fn('nts 

all:'simibttO('(IIX\VllS3boot the Wtof disa\1ion int,TWltt 

risk ldjl.blmc-nt. asdi9:usscd LU'Idcr ro~ I of this ttpOrt 

1

• TI-t: \\orJ Mtb.lb3d: .. i$ !oQr:r'lctimcs u.W ton:(~r tOaD'I·d.-fcrnlof'.pa)'rrl(ntmbod. The term '"~iTANc-k .. alsoma) t~.frr sp. ... 

('ifiCJ.!~· toa.n:am.n~"tf"-.'nl ucd«-.,r,hXfl:tncmplo)«m~ 

fttl1M il'ktnli\'t<'QnlpM.-.11iotJ ~)'m('B\$ pll"'.'iou.~• fl'tl.'i1.\.\i b~ 

tho: crnf'll~ te il" certain ffl); outoom:so:\.'Ut. ~tion 304 of lhi: 

SJrb.l~-O>k)· Al1 of 1001(1l U.S.C. mJ; •hictt•Jlllli..• 10 
111 


71718239.eps

bala <~.'<i risk-laking inccntirtS bydiS<Ouraging spe· 

cific I)'JX'S of b<ha1•ior. While po1cn1ially cfl'ecli1~. 

1hey do no! affect most risk-related decisions and are 

not triBgered b)' most risk ()utoomes- the narro" 

focus of these arrangements mean !hat tile)' are 

unlikely 10 <"Ontribute meaningfully 10 balance 

Progress on performanre-based deferrol for !he 2010 

performance )~r ~~~s mos1 common for senior 

exccuti\'CS. Many lirms arc now in the process of 

re1;sing armngements to be used for the lOll perfor· 

mancc year and are extending performance-ba.st'<l 

deferml C01~rage 10 more employees as a mechanism 

10 provide prudent risk-taking inren1i1~ Some flrms 

a~~ implememed, or are implememing. 

perfom>ance-based deferral for all emplo)""' receil'· 

ing deferred ill00lti1-ecomp<nsa1ion. while o!hers are 

doingS<> mainly forempiO)'ffi whose au1hori1ics and 

influence over risk laking 3re such !hat risk adjus!· 

ments might h3'eonly limi!ed efl'ecti ~ness in balan<· 

ing risk-taking incentiws~ such as senior managers 

within business lines and other employees engaged in 

activities that in\'OI\'e ris~s orera long duration. 

Next Steps 

Most of !he firms in the horizon!al te\iew h:n-e made 

signiflcant changes lo !heir deferml arrangemen!s. 

Many firms in the horizontal O:\iew have increased 

the fraction of ina?nth·t! compensation that is 

dcfcm.'<l for both seniorex«:utive$and other employees. All firms haw more work to do 10 impro1-e !heir 

performance-based deferr.tl arr.mgcmenl< firms 

may aiS<> flne·tune !he role of defcrrol rda1i1~ 10 risk 

adjus1mems as they gain c>pcricnce 11ith how the 

1wo 11~rk 10gc1hor. As flnns dcwlop and fine-!Une 

deferrol armngemenl< firms should 0\'aluate how 

~~~ll ese deferral arrangemenls :n~ 11t>rke<land 

make impro,·cmems as n=l)'. Tile Fedeml 

Resen·c will monitor and eocourage progress and 

work 10 ensure I hat pmctices are eflfctive. 

Topic 3: Other Methods that Promote 

Balanced Risk-Taking Incentives 

Risk adjustments and deferral wi1h performancesensilive rcalUres represent importanl mechanisms 

cll.icf t:<l\."\111\~ oiTk\'fS.and clli..i finanri.al offll."tfSo( rublic 

b.:tnki~ol);anization..\ ii an ~pk ol lhls mort ((\"'\ifw: 1~-p.: 

of -d3-a'bacl. ~ tcqLJif'l."l'D«<I. N'..-J.rly all U.S.·l»$cd firms int~ 

horizontal mW.·are pubiW.i)· tradN. and tl'lcP.ofortsubj.'\1 10 

1bisprtl\~ . 

<X1ober lOll 17 

for achiering balanced inccnth'CS for taking risk. The 

intemg<tlcy guidanre also idcn!ifies the use of longer 

perfonnance periods (for example, more !han one 

year) and reduced sensitivily of a•ords to short-term 

performanre as mel hods for achicl'ing balance Our· 

ing the horizontal review. we obserwd the use of 

bo1h me~hods. I hough neither ·~s uni1~rsalty used. 

Evaluating Performance: Emphasis on 

Long-Term over Short-Term 

Firms used longer performanre periods (thai i< a 

backllard-looking muhiycar assessmcn1 horizon). for 

example. for senior c~oc:utiw~ in some cases, and in 

others for non-oxecut i1~ employees. Measuring and 

Cl'alua!ing performance or a11~rds on a multiyear 

~is illlo"~ for a gJ(;lt~r portion of risks and ris~ 

outcomes to be obse"~'<i 11;thin the performance 

assessment horizon. thus gamering many of !he b<n· 

efils of a defcrml arrangement wilh performancesensitive fe:uures. One simple variation involves using 

risk ou1comes from prior-year ac1ions as a consideration in reducing current.yea.r incrnti,·crompcnsa· 

lion award doci~on~ To be e!Tccti1~ muhi)~at 

assessmems should be b.1sed on policies and procedures that gh·e appropria!e weight to poor ou!comcs 

due 10 pas! docisions. O!herwise. ad1wse ou1comcs 

may be cfl'ec1iwly ignored due 10 an emphasis on 

current~year perfom1ance. 

Damping the sen~! ril)' of incentii'CS 10 measures of 

short·!crm performanre ~~~sa d•oice made by some 

institutions to rein in inctmhts when. for example .. 

concerns arose abou1 !he signiflcance of the incenti\'CS or risks ilwol\'td. Fore.xarnple. increasing bonus 

pools or indiriduAI 111 ~rd amounls a1 a lo11~r rate 

when financial perfonnance is 11tll above targe1 iti'CIS 

can limit inctnti\~':S 10 lake large risks 10 achie\'C 

exucmc lc\-els or performance. A cap on incenth·c 

compensa1ion a11~rds b<)ond a rertain le~~l of per· 

formance is another example. However. in the hori· 

zontal rericw. there were few instanres where such 

caps and reduced se ~1iri y 11trc sunicien! by them· 

seh~ to balance risk-laking incemii'<S. 

Next Steps 

The interagency guidance urges large banking organizations to acli, ely monitor indus l)~ ar.adcmic, and 

regula!ory de1~ opme s in illOOltirecompensalion 

prae!ietSand !hcol)' 10 iden!ify new or emerging 

me! hods that arc likely 10 impro1e !he organization's 

long-tenn financial 11tll-being and safely and sound-
112 


71718240.eps

18 IIX'<'nti\e Compensation l'raelict:. 

"""' Th< F<d<ral Rtstn~ ,.;11 do the same and ~ill 

encoumge firms to ust methods that are ntO>I approprime for their circumstanres. 

Topic 4: Covered Employees 

ldennf)ing the full Stt of emplo)<es •ho rna) indi· 

,iduaJ~ or a~U«ti\'d) «post tilt fttm to matcriol 

amounts of risk in crucial step to .. rd mallaJii!J 

rill., associaud •ith incenl~~a>mpeosotion. 1\lth· 

out identif)ing the rek\~nt empiO)ees. a finn c;~nnot 

be >Ure it has proper~ designed its inc:l!ntire a>mpen· 

>at ion arrangements to prmide appropriate ri>k· 

taking inetnti\"eS. 

Three Categories of Covered Employees 

Th< intmgm<J' ~idanct describe;. three catttories 

of ;ud! nnplo)ttS. •flicb t~htr are rd'tmd to a. 

'CO\ffld nnplo)~-= 

• other indh idual employees able to take or influence 

material risks: and 

' giOUJ)> Of similar~· compensated indi\ iduaJS 1\hO, 

in aggrepte. can take or influence material rill<~ 

lnctnt~e a>mpensation aml\gtlllC!ItS for all eo~er<d 

tmplo)ces5hould b< appropriatd) lxdanced. ~~~~­

k» of • lk"lher the ""~red <mplo)ce ;, a .mior 

c.e.:uti,e. an indh·iduaJ. or pan of a group of ~mi· 

Jar~· compensated indhidual~ Though the Fedml 

Rcsef\t has no taf!!cl number or quota of cowl\'<! 

emp!O)·c.:s for any firm, many of the lafj\<">t firms 

ha\e detennined they haw thousands or tens of 

thoU>ilndJ of CO\~r<d empiO)·ees. 

Standald Approaches to Covered 

Employee Identification 

Finns foliO\\ oneoftwogenmlapproaehe> toid<ntif) CO\Cr<d nnploy= ~te approach im oh e. dC\d· 

oping and follo•ing a s)>tematic p= that idcnti· 

fi1S types or risk that each employee (or group of 

empiO)«S) takes or influeno.'! and thataSASCS the 

materiality of the risk< Such a p= should 'cast a 

wide net' and should consider the fullmnge or t)pes 

andle\eritiesofrisk ~finnsbtin\esledin 

enhanced information syst(I!IS to faatitlt< th11 proee». Man) firms in the horizontal It\ i'" folio\\ thi> 

appfll3ch. 

Th< S«<lnd approach ck:,ignat<:> a '"tl) Ia~ set of 

nnpiO)<e> as CO\tl\'d, such as all rn>plO)'«S reOO\ing 

any in<ttlli,~romptn<ation. or all nnplo)~ subject 

to a subset of the firm's iiX'<'nti\'e compensation 

plan~ Although this reduces the ell'on requir<d to 

identify a>ver<d tmpiO)= firms still n.OO to iden· 

tify the rele-~nlt)-p:s and S<\erities of risks that are 

inctnti\iud through iiK'ellt~ea>mpensation 

amngcmmb to b< sure iottntnes to take such risk> 

arebolancN. 

Man) firms appropriately id<ntif) at least some 

groups of similarly a>mpensated employ«:< "no may 

coll«ti\'cly expose the firm to material risk. 

Examples include originators or mongagtS, com mer· 

cia! lending officer>. or groups of tr.ders subject to 

similar incenti\~ a>mpcnsation amngement~ 

Establishing Robust Processes Going 

Forward 

SC\~ral firms h;n-e )<Ito establish robust proc= 

for identif)ing co,ef<d Clllp!O)a'l that are a>nsistent 

with the intmgenC)' guidanco. e.pe.:ially for identify. 

ing groups of covered employe--s. Some firms rely 

he3\·ily on me.:hani(ll) materiality thl\'lholds in their 

identift<ation prottJS. Formmple. on~· empiO)ces 

able to make deci.ions that a>mmitatltast Sl billion 

of tb< fim's<ronomic:capilal might be eligible for 

consid<mtion as CO\fflO ClllpiO)-..s. or~ cmpJO) · 

cesalxnea gnen 1<\tl of totala>mpensation. Such 

materialit)thrtSholds as opplied b)' mOSt firms to 

exclude nnpiO)e>:s from being a>nsi<lel\'d cowl\'<! 

empiO)'CCS ha\·e three common weaknesses: (I) they 

often fail to capture the full extent to "1lich an 

empiO)'e\! maye<po>e the finn torisk.(2) they tend 

to exclude potential 00\~1\'<l emplo)<es who may sig· 

nir~<antly influence risk taking but do not make final 

risk dtci>ion$. and (3) the) often ignore groups of 

similarly«>mpcn>3tednnpiO)ces In mie-&ingtll< 

firms ust of threshold\ "e ~und that Ullder some 

circumstancel. a suitably chOStn materiality thrtSh· 

old a>uld appropriate~ play a a>mplementary role in 

idcntif)ing CO\~r<d empJO)CCS if used to include 

employees as corer<d ClllpiO)'CI'l. 

FBOs \lith U.S. operations that "~re pan of the 

horizontal mit\\ face special challenges in dC\doping procedures for idtntif)ing CO\er<d cmpiO)«S for 

purposes of tht inttratmt) guidantt. Gtnerall). 

home-country supen i>OO np.'<tthcir staodards to 

be met by the a>n>Oii<lated organization. and so in its 
113 


71718241.eps

U.S. o~rations. an FBO must mett both home· 

count!)• and U.S. regu atorye<pe<:tation~ Ma11yof 

these lirms ha\'e home-rou ntry supervisors whose 

regulations focus on a more limited set of employees 

than dC$Cribed in the in1eragency gutdaoce.17 As a 

result. these fimts n«d to develop proc:esses to iden· 

tify both CO ~rcd employees in their U.S. o~rn ions 

lor ' Jlplication of the interngency guidanre and those 

employees subject to home-count!)' regulation. The 

number of eo1~rcd emplorees for purposes of the 

interagency guidanre in U.S. o~rn ions of an FBO 

mar mred the number of employees subj«t to 

home-oounuy regulation. 

Next Steps 

All firms in the horizontaii'C\icw now 1\'<ognize the 

importaoce of establishing sound incentil'eeom~n

1

' Sup:t\i~rs in trUII)' otlx'r juLi:5d.ictions r..-quire tt..."ir finm 10 identify on~· lhcif cqukal-nl o( indi'iidual 00\WC'd rolpky)\\~ 

ofiC'I'Ill$ing N~crilfitySI3:1'1d3rds I hal r~0.1 ancntioa 103 rrlali\o:f)'NinurnbcrofindhiduaJs. 

<Xtober 2011 19 

sation programs that do not t1tcour..ge imprudent 

risk taking for those cmployct<~ who can indi1idually 

aftect the risk profile of the firm. In addition, many 

finns have identified groups of imilar CO ~n· 

sated emp o)~ whose combined actions may expose 

the organiu.tion to material amounts of risk. Some 

finns h3\'e put in place a robuSt r= for idcntif)'· 

i11g re e~~111 i11di,;duals and groups of employoes. 

uith the na,ibility to adapt to the changing business 

em·ironment o\·er time. Howerer. some finns are still 

working to idemify a complete set of mid· and lower· 

level entplO)'<'OS. and others arc working to ensure 

their pi'OC\'SS is sufficiently robust. The Federal 

ese/'\~ will II'Orlt 11ith the firms to ensure that progress continues. 
114 


71718242.eps

Establi~hment of balaoccd risk-taking in«:ntives 

should be support«! by the engagement of risk· 

manag<mcnt and oontrol personnel in the design and 

implementation of incenti -ecompensalion arrangeent~ in«:nti1eoompen~t on for such personnel 

that is independent of the financial performan«: of 

the businesses they ovci$Ce (in order 10 limit oonfliets 

of intere;t). pr.tcticts to promote improvements in 

the reliability and eOOCtireness of incenti,-ecompcnsation systems o'-er time-. and impro"emenlS in corporate governan«:. These features are discussed in 

topics 5 through S below. 

TopicS: Risk-Management and 

Control Personnel and the Design of 

Incentive Arrangements 

Properly identifying risks attendant to emplorces· 

acti\'ities and setting suitab!t balancing mochanisms 

an: critic;!! elements of pro1iding balanc<d risk· 

taking incentives. The inte,.gcncy guidance notes 

that risk·man(l$ment proo:sses and internal controls 

should reinforce and support the devtlopment and 

maintenance of balanced incenti\'erompensation 

arrangements. Risk-management and comrol personnel (including Internal Audit) should be involv<d in 

the design. operation. and monitoring of incenti1·e 

oompe ~11ion arrangements because theirskills and 

expertise pro1ide essential jperspeetil~ and support. 

Risk-managementstan: in particular. should partici· 

pate in the firm's anal) s and deci~onmaking 

regarding the identification of oorored employ~ the 

seleetion of any risk-sensiti1·c performan«: mclrie& 

the dCI·elopmcnt of risk-adjustment metltodologi~ 

and 1~1ing triggers, and the orcrall cO'ect ~tness of 

the finn's balancinge!Torts 

At all firms in the horizon!all'l.~icw, eertain limelions. such as human =•= and finance. tr.tditionally were ill\'OI\·ed in incenti\'erompensation 

decisions and in the desigru and implementation of 

incenti,·t compensation arrangtments. Howe\'er, this 

21 

role tr.tditionally inl'oh~ liule or no focus on inecn· 

tii'<S to take risk or the risk associat<d 11ith the 

cmplorec's aetil'ities. Risk·management personnel 

traditionally had re ati~tly little in1oh~ment in incen· 

til'c compensation design. and their itll'olvement in 

decisionmaking 11~1 often limit«!. for ~'ample-to 

only suppiJing information abou1 breaches of inter· 

nal policy and proc<durc by indi1idual emplorees or 

units.. Howt\'er, a few finns did incorporate risk 

measures produc<d by risk-man(l$ment personnel 

into financial performance measures used in inctn· 

til'e oompensation dcdsionmaking b¢fore the crisis. 

Increased Involvement of 

Risk-Management Personnel in Design 

and Decisionmaking 

Risk·management perronne-1 are now im·oh'ed in 

incenti\·ecompensation system design and decision· 

making at virtually all firms in the horizontal n:1iew. 

How-cwr. the intensity and nature of im·oh·cmcnt 

\"Jries. For example. risk·managrmtnt functions 1\0\'' 

pro1ide significant risk-related input to the boardle~~l deci~onmaking process for indi1·idual senior 

executil'e ill('Cntil~oompensation at all firms and for 

bonus pool size decisions at firms at wbic.h pools play 

a role. Mostlirms consider some quantitati,·e risk 

mea)ures in making atleaSI. some incenth·e oompen-

~tion dec on~ and these an: usually pro1ided by 

the riskand finance functions. Nonetheless. at some 

finn~ risk c.xpertS primarilr play a peripheral or 

informal role 

Comrol.linance. and risk-management stall members provide some input to indi1·idual employee per· 

formall('C ~ie11' at many firm< For example. they 

report breaches of policy and proc<durt or rate the 

··risk awartncss') or adherence to the linn's risk 

appetite of indi1•idual emploreesor business unit& At 

!inns that usc committee structures in their incenti\'C 

compensation deci~onmaking process. oontrol. 

r.nanec. or risk-management personnel usual!)' are 

among the members of commiuees. AI most firms in 
115 


71718243.eps

21 lncenti,·c Compensation Practices. 

the horizontal n"iew. risk· management and control 

functions are also involved in identification of COV· 

ered employees. 

At firms where risk-management personnel are 

intensely involl·ed in basic-design decisions for the 

incenth'C compensation system. as well as in determining details of the ri k·n~ated elements of the 

inctnti,·e compensation process o1~roll. progress on 

risk-taking inrentii'CS has tended to be faster. At 

fim1s where risk e.\perts play a peripheral, informal 

role. progre>S has tended to be slo11~r. primarily 

because other personnel to nd to have less e,,perienee 

and e<pertise in designing risk identification and 

mcasul\'mcnt fratun.'S. Sc\'cral firms remain in the 

Iauer category. 

Next Steps 

The main challenge going lb"mll ~to ensure that 

risk-management and control personnel are actively 

engaged ~ith incenti\'e compensation and that 

impi'O\·ement) in risk management and in recognition 

of risks the firm takes are incorpomted into eentil~ 

compensation decisionmaking. The Federal Rese,-e 

will continue 10 work \\ilh firms to ensure that such 

personnel have an appropriate rok 

Topic 6: Incentive Compensation 

Arrangements for Stan· in 

Risk-Management and Control Roles 

Improper incemirccompcnsation arrangements can 

compromise the independence of stan· in risk· 

managoment and control roles. Fore.<ampl~ a conmot of interest is created if the performance meas· 

uresapplicd to them. or tl>e bonus pool from 111\ich 

their awards are drown. depend substantially on the 

financial n.'sultsof the lines of business or business 

activities that such stan· Ol..,r;ee, Such dependence 

can gh'e stan· an incenth·eto allow or foster risk laking that is inconsiS!cnt 11·ith the firm's riskmanagoment policies and control fromt~~ork or the 

safety and soundness of the firm. Thu~ risk· 

managomcnt and control personn<l should be compensated in a way that makes their incentives independent of the lines of business whose risk taking 

and ineentirecompensation they monitor and control. Soch staff includes not only employees a;,'igncd 

to finnwide risk-management or control fuoction'-

but also employees 111!0 perform similar roles while 

embedded 11irhin indi1iduallincs of business within 

the firm. 

Maintaining the Independence of 

Risk-Management and Control Personnel 

The firms in the horizontal review ha~~ completed 

much of the necessary work in this area. Pcrformanc. measures applied to staff in risk-management 

and control roles are usually oriented to the performance of their Ol'trsight duties and not the perfor· 

mance of the line of business the)' owrsce. Their 

incenth·e compensation may be indirectly related to 

financial performance. if. for exampl~ the bonus pool 

is dro1111 from the firm11idc pool. which is related to 

finnwide performantt. In most cases. linkage to 

finnwide performanre is likely to be too 11<akly 

linked to control and risk-management decisions to 

pose a significan! connict of interest. 

Where more din.'<! or substantial potential conOicts 

of interest have arisen, some finns achi"'Cd indepen· 

dence by moving risk-management and control function personnel out of linc-<lf·business incentive com· 

pensation plans or line-<lf-business bonus pools. 

establishing separate plans or pools for them. Other 

fimlS established separate bonus pools for stan· in 

risk-management aod control roles. the sizes of 

which do not depend din.-ctlyon the financial perfor· 

mance of a particular line of business or business 

actility. 

At some firm.~ ow<r·l"~l risk-management or con· 

trol stan· members who are embedded in business 

lines receire their incentive compensation awards 

from the bu~ness line bonus pool. Such practices can 

beaeeeptable if the rele1~nt stan· members perform 

funotions that are unrelated to risk-taking decisions 

and if the product of their work is unrelated to 

incenth·e compensation decisionmaking. 

Some finns include comments from cross-function 

re\iews (such as 360 degree re\'iews) in inctnth·e compensation decisionmaking for all stan· memberi This 

m~ the possibility that business line revi011~ could 

influence incentil~ compensation deci~ons for riskmanag.emcm and comrol stair members e''Cn if no 

formal link to financial performance exi<IR In addition. some firms ha,'e incenti\·e compensation 

arrnngements for staff in risk-management and control functions that are subject to adjustments based 

on management judgn>ent. Clear guidance from policies and proo.'durcs. clear documentation of indi-
116 


71718244.eps

"idual judgmcm-based adj ustmems (and deci~ons 

made under such policies and proo.'dures). and 

review by internal audil he~p to ensure the incenti\'e 

compensation awards are not swayed by business line 

results 

Next Steps 

As part of its nonnal supenision of the indcpen· 

dence of risk and control funCt on~ the Federal 

Rcscn:e will continue to be attenti\t: 10 1he risk· 

related incentii<S pnwided by the incentil~ compen· 

sation arrangements for their personnel. 

Topic 7: Practices Promoting 

Reliability 

Firms should regularly reviewwhetherthedesign 

and implementation of their inremhoe compensation 

S)~tcms deliver appropriate risk-taking incentil\-s and 

should corroct dcfooiencies and make impro1·cments 

that are suggested by the finding.~ The interagency 

guidanct mentions sereral practices that can contribute to theeOocti\'eness of such aeti,•ity. including 

intemaln.'l'iell~ and audits of compliance with policies and proo.'du~ monitoring of results relat i1~ to 

expectation& and simulation of the operation of 

inctnti\'t compensation arrangements before 

implementation. 

Importance of Internal Reviews and Audits 

Internal re\'iews and auditS of complian<X 11ith policic:s and pi'OC\."'<Iuresare imponant to ensure that the 

incenti\'C compensation system is implemented as 

intended by those employees iu,•oh'td in incenti\'e 

compe ~1tion deci~onmaking. For example. if pro· 

Cl.'dures r>.'Juirc that spcciltcquant itat il~ measures of 

risk are to be included in financial performanre 

measures us..'d in decisionmaking. but they are not, 

the scnsiti1ity of decisions to risk taking probably 

would not be as intended. Though the internal audit 

function should play a key role in this aeti\'ity, other 

functions such as risk management. finance, and 

human resourctS also should be in\'OI\'ed, 

An incenti\'ecompcnsation S)~tcm may be implemented as intended. but it may still fail toach e1~ the 

desin.'<l relationship bet~~• risk and re~~rd be<ause 

features of its design and operation do not work out 

as expected. Oetcetingsucll problems requires that a 

fim1 monitor relationships among measures of short· 

a!MIIong·run financial pcrt'ormano:. amounts or 

<Xtober 2011 23 

incenti\'c compensation 3\l~rds. measnrt"S of risk and 

risk outcomes, amounts of ultimate payments of 

defemxl incenti\'C compensation. and other factors 

relerant lo incenth·e compensation decisions. Such 

monitoring bears some resemblance to the "backtest· 

ing" that is often done for risk-management models 

and S)~tcms To be eRocth-., such monitoring should 

include so eq antitatil~ anal)~is. but because all 

incenti\'e compensation sys.tems in,·oh'C some exercise 

of human judgn1ent in decisiomnaking. efl'«:~ "e 

monitoring is not likely to be purt~yquant tati\'e or 

mechanical. Lmgo banking organizations are morc 

likely to require some usc of automated s)'>tems to 

adequately monitor the effecti,~ ess of inrentive 

compemation arrangements in balancing risk-taking 

incentir<>. especially systems that suppon capturc of 

rclmnt data in databases that support monitoring 

and anal)'Sis. 

Next Steps 

All organizations in the horizontaJn..,iew ha~~con

siderablc work remaining to fully implement prac· 

titts promoting balan<Xd risk incenti,·es in their 

iocenth·c compensation arrangements. Few organizations perfonned extcn~re rcl'iell~ and analyses 

related to risk-taking incenti1~ before the crisis In 

some cases internal audit TC\'iewed other aspctts of 

inctntirecom.pensation activities. such as inctnth't 

compensation a11~rd disbursement pmctittsor 

adherentt to \'<Sting policies related to 

time-of-ser.·ire. 

0\'er tim~ as incentil~ compensation is 31 ~rded and 

paid out and risk outcomes become better knoll'n, 

finnsand their superYisors 11ill learn more about the 

reliability of methods for balancing risk-taking inrentil'es and the eRC<ti\'enessof different methods of 

assessing rcliability. In the mcantim~ the Federal 

esen~ will ork 11ith finns as they dC\'clop the nceessary systems and cap.,bilities and ll promote 

experimentation and inno"ation. 

Topic 8: Strong Corporate 

Governance 

Actil~ and eO'ecti,·c owrsight of in<Xntil~ compensa· 

tion practices by the board of din.-ctors is a key clement of the interagency guidance. The board of 

din.'Ctors of a larte banking organilJition. or its delegated committee. should ac il~ y orersee the dereiOJ>ment and operation of the organiJ.ation's incenti\'e 

com~nsation policies. S)Will~ and related control 
117 


71718245.eps

2-1 lncenti,·c Compensation Practices. 

processes. The board of dimtors or the dekgatcd 

committees of such organi !lttions should also monitor the cffecti\'eness of incenti\'e compensation 

arrangements in balancing the risk-taking inctnti\'CS 

of co'·ered employees. 

Most of the firms in the horizontal,.,;"''' already 

had in place a board-l01·<1 <Qmpcnsation committee 

composed of independent dill.'ctors. While historically these committees hare been acth·ely engaged in 

decisions relating to the inctnti\·e compensation 

arrangements for rertain senior c.:<ecutives,their 

ill\'ol\'tlllcnt in oYcrstcing I he incenti\'tcompensation 

prnctieesand arrangement.s relating to other covered 

employees (in<:luding non..,~ecutircs) has inrn:ased 

considerably during the horizontal reriew. All firms 

in the horizontal re1icw h3'1unhanc..'<l the role of the 

board in orcrseeing the incentirc compensation 

system for all covered employees and are now paying 

iucwased attention to risk-wlated aspects of iocentire compensation. Some r.mts hare established man· 

agement committees that inclnde wpresentatii'CS of 

risk.management and control functions 10 support 

their cllort& Not11ithstanding progress made to date, 

fimtS indicated that they ,,;n continue to implelll(nt 

enhanced corporate gowmance practices and that 

these practi('<'S will continue to e~ oh~. 

Progress in Facilitating Effective Internal 

Communications 

Most firms ha1~ establishoo mechani~ns to facilitate 

communication lxtwetn the compensation oommit· 

tee and the risk and audit ccmmittec& Many finns 

ha\'\~ members of the compensation committee that 

are also members of the risk and audit commiuees. 

Other fimtS wly on regular m..'ttings between the 

compensation and risk comnti u~ whik others ha~e 

not yrt enhanc.."d their communications S)'Stcrns and 

rely on oommunicalions that are more ad hoc in 

nature. 

The board of directors or its delegated commiuce 

should revi011• and appro1~ policies and procedures 

that appropriately address corporate standards and 

processes go1·erniug the design. appro1'al. administra· 

tion. and monitoring of inctnti\'e compensation 

arrangelll(nts for covered employees. At some firms 

in the horizontal w;ew, the rel01ont body is not yet 

consistently re1•iewingand approl'ing these standard.< 

The board of dill.'<lors should n.'gularly revi01v the 

results of monitoring of inecnti\'c comprnsation 

arrJngcments described in the Pl't\'ious section and 

results of other actil1ties undertaken to promote reli· 

ability of the iocentil't compen~1tion S)~tem. For 

example. boards should recti'~ periodic wports that 

review incenti\'C.COmpcnsation a\\ards and payments 

relati1~ to risk outcolll(S on a backllord-looking 

basis to determine "'hether the organization·s incentil'ecompensation arrangements may be promoting 

imprudent risk taking. As noted pre,·iously, at most 

finns such wports are at a relatircly earl)' stage of 

dmlopment. While some boards undertake an 

annual re'iew of the cff~.'tti\-eness of incenti\'e com· 

pensation in al'oiding inappropriate inccnti1·cs to 

incur risk. many currently wly on periodic pn.-stnta· 

tions by the cllicf risk officer or other risk· 

management stall' to the board of diroctorsor its 

compensation committee. the content of which \-aries 

considerably from firm tO fimt. 

Next Steps 

Though firms a~~ implemented impro1~ corporate 

gowntancc practice& the efl'cctil'tnCSS of such ptJctices 11il1 not be known until S0111( years of experi· 

enre hare been accumulated. Errectil~ness will 

depend on the allentil·eness of lll(ntbers of compensation commilln'StO risk-taking inrentil'cs. The Fed· 

era! Rescrl'e will continue to work to promote efl"cc. 

tive go,-crnanre of i!K'enti\'ccompen&1tion practices 

at banking organization• 
118 


71718246.eps

Some obscrwrs hare betn in1eres1ed in comparing 

progress of fimrs h<adquar1ered in diffcr<nl jurisdictions in improving their illQ."llli\'eoompensation prac.· 

licts, for example-in progress relalire 10 lhe FSB 

Principles and lmplemmuuion Stmrdiml< 

About one·lhird of 1he la'¥e banking Of¥l'ni7.alions 

included in 1hr horizonl:!l rericw are h<adquancred 

ouiSidelhe Uniled Slate$. Almosl all of 1he FBOs in 

the horizontal Te\'iew are lu:.adquartcred in Europe 

(including 1he Uniled Kingdom). We obscfl'ed prog· 

ress in implemenling I he inleragrncy guidance. which 

is consis1cn1 11i1h 1he FSB <locument!, a1 bo1h U.S. 

banking organiza1ionsand FBOs. Howe1~r. 1he inleragency guidance. whilcconsisl<m 11;1h I he FSB Prin· 

<iples and lmplemematimr Stant/artis. is more de/ailed 

and demanding in many respeel~ Thu' sa1isfying 1he 

expee1a1ions implied by 1he FSB documenls is nol 

n=trily enough 10 salisf)' 1he exp<e~alions in 1he 

interagency guidance. 

Conformance with Interagency 

Guidance 

In geneml. progress on conforming to the interagency 

guidance is ~milar at the U.S. banking organiza1ions 

and at the FBOs in the horizontal re';"'"· Firms that 

are more and less far along rnn be found in both sets 

of finn• Wilh resp<CI to P"rlicular aspeeiS of the 

guidance. the FBOs hill~ ~ad more diOioulty in iden· 

tifying cormd employees in their U.S. oper.uions (as 

noted pn.~ iousl). fc1r foreign per~;sors employ 1hc 

concept of groups of co1~red employees. instead 

focu~ng their attention on r< ati1~ y small numbers 

of senior and highly paid employees). l'rogress on 

confonning to 1he clements of the interagency guid· 

anee 1hat focus on corporate go,~mance and the role 

of risk-management and control personnel is ~milar 

a1 FBOs and U.S. banking organization~ 

Progress on achie1•ing bala net-d incentiw eompensa· 

tion arrangcmems is similitr on 1he "holt across the 

two groups. butt IN: balancing methods employed and 

25 

the rate of innoration are diffcr<nt betii\'"Cn the 

groups. For risk adjustment~ some for<ign supet~i· 

sors ha~umphas~ed risk adjustments mainly at the 

le~ el of firm11ide or business line bonus pool& Thu~ 

some FBOs have made progress risk adjusting such 

pools but ha,·c made les. progn.'SS implementing risk 

adjustments down to the ield of the indiridual 

employoo. 

Some obscr~ ers ha~t betn panicularly interested in 

the details of deferral praeliecs. focusing on the share 

of inetntire compensation a11~rds that isdeftrred 

and the use of equity as a '•hide fordefertt-d incentil< compensation_ Numerical examples of deferr.!l 

fraclionsscl out in the FSB Princip!ts and lmpftmetr· 

lllfio11 S1mulmrls are some!imes used as a benchmark 

(60 percent or more for senior mcutil·<$. 40 percent 

or more for other individual "material risk takers," 

which are not the same as CO\'Ctt-d employees). Defer. 

r.!l fraelions are at or abo1•e these benchmarks at 

both the U.S. banking organizalions and the FBOs in 

the horizontal review. 

In somcea"' substantial defem!l fractions are 

achicred in dinerent 11ays. As noted pn.~ iously. most 

U.S. firms and some FBOs usc a cash-stock table that 

increases the deferral rate as the amount of incentii'C 

compensation increase. As a proclieal matter. this 

resuhs in substantial deferral rates for scnion<ecutives and for some employees. In contrast. as noted 

pre1•iously. some European Union (EU) supefl'isors 

prescribe some elenltnts of pay structure for some 

employres at EU banking organization~ This also 

resuhs in substantial deferral rates for 1hose 

employoes. 

European Union Approach to 

Deferred Jncentive Compensation 

In many eases the pay structure under the EU regula· 

tion issomrn·hat differ<nt th3n that seen at U.S. 

banking organizalions. Undersome national implemenlalions within the EU. the dcfcm'd ponion of an 
119 


71718247.eps

26 lncenti,·c Compensation Practices 

inctnti\'t compensalion aw3rd is rt"Quired to be 

grnmed half in an equity-linked instrurntnt and half 

in cash or a cash· like -.hick The upfront portion of 

the incenti\'e oompens:uion award is required to be 

paid half in cash and half in stock subj(ct to a reten· 

tion requirement of sc< months 10 one year. Though 

the owall fmctioll of the incentil~ compe11sation 

a"md granted in stock is substantial ill such implementation& the upfront stock subj<ct to a retention 

requirement is likely to han: a limited balancing 

impact on risk-laking inrcn1h·csdue 10 1he- shon 

retention period. The impact of the defcrrnl ponion 

depends on perfonnance conditions: in the absence 

of performance condition& dcferrnl cash will ha~·e 

only a modest balanci11g impact ~nee the amonm 

ultimately n>cti1·ed by the employee is rnlueed only in 

thecwntof the fim•'s failure. 

01·ernll. the net e.<posure of an employee to a finn's 

perfomtance OI'Cr time is not necessarily larger under 

the EU n:gulation than under the ~mpl<r structures 

oficn seen at U.S. firms. For examp ~ if 6() pcn.'tllt of 

an inctnti\'erompensation a\\-ard is deferred for three 

years. half in stock and half in cash that I'<Sts unless 

the firm fails. then only 30 pero:nt of the incentire 

compensation a11~rd is c'poS<'d to poor performance 

short of failure. In contrast. suppose all deferrnl 

"""rds are in stock defem'd for thn.-e )'"'"'as is 

common in the United States. If the same 6() pen."nt 

of the incenti1~compensation award isdeferrnl. the 

whole 6() pcrttnt is exposed to the ~~nation in the 

~~ue of the stock. If the stock is also subject to eff<Co 

il~ performance condition& the whole 6() pen:ent is 

exposed to the condition& The details of resting and 

other performance conditions arc particularly impor· 

rant to the o1·ernll balancing impact. 
120 


71718248.eps

Rcinfom:d by the supervioory acti1itics undenaken 

through the horizon1al n.~ iew. the large banking 

organizations in the re\'ie\\' ha\'c made significant 

progress 11~rd enhancing their incentil·ecompensation arrangcmtnts in 1111)~ that pro1idc appropria e~· 

balanced incenti,-es to take risks(as outlined in the 

interagency ~uidance) and promote safety and 

soundness. As described in this report. ho•t~~r. most 

fimts still haresignific:mt •mrk to do to ac ie~t full 

conformance with the interagency guidance. 

The Federal e><"~ remains committed to helping 

lllOI'C the industf)' forn~rd in d"'tloping and implc27 

men1ing in<tnthre compensation practk:es thai are 

consistent with prudent risk management and safety 

and soundness. Continued supervisor)' attention 11ill 

be IOO.sed on f unher refinement and implemtntation 

and on making appropriatechan!" as business conditions change and business strategies erolre. 
121 


71718249.eps

m~w.federa resel\~gov 

lOll 
122 

5http://www.pewresearch.org/fact-tank/2017/03/08/immigration-projected-to-drive-growthin-us-working-age-population-through-at-least-2035/ 

Q.8. Many economists, including President Trump’s Chair of the 

Council of Economic Advisers, have long advocated for less restrictive immigration policies to help grow the U.S. labor force, especially in light of an aging population and low birth rate. According 

to the Pew Research Center, without a steady stream of a total of 

18 million immigrants between now and 2035, the share of the U.S. 

working-age population could decrease to 166 million. 5

What repercussions would restrictive immigration policies have 

on our workforce and economy? 

A.8. Immigration is an important contributor to the rise in the U.S. 

population, accounting for roughly one-half of population growth 

annually. And population growth, in turn, affects the growth rate 

of the labor force as well as the growth of the overall economy. 

Thus, from an economic growth standpoint, reduced immigration 

would result in lower population growth and thus, all else equal, 

slower trend economic growth. However, immigration policy is not 

the purview of the Federal Reserve but rather is the responsibility 

of the Congress and the Administration. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER 

FROM JEROME H. POWELL 

Q.1. Alternative Reference Rate: Some underappreciated work that 

you have guided at the Federal Reserve is that of the Alternative 

Reference Rate Committee. Global regulators have acknowledged 

that at the end of 2021, banks will no longer be required to submit 

to the panel that determines LIBOR, meaning that the rate could 

stop publication at that time. LIBOR is currently critical to the 

smooth functioning of our financial system, as it underlies $200 

trillion in notional value, or ten times U.S. GDP, including a significant amount of floating-rate mortgages. As the FSOC’s annual 

report highlighted, if LIBOR disappears without a liquid market in 

the replacement rate, the effects could be catastrophic. Yet a switch 

to an alternative rate, the secured overnight financing rate, requires tremendous collaboration by the private sector and the official sector and the creation of financial markets that would facilitate the arbitrage between LIBOR and the secured rate, and the 

creation of new products in the new secured rate. 

Do you believe end users will demand products in the new secured rate sufficient to build a deep and liquid market in the secured rate before the end of 2021, even though first movers in this 

space are likely to pay a premium for the product before the market is fully developed? Why? 

A.1. As you note, the Financial Stability Oversight Council (FSOC) 

has highlighted the potential risks to U.S. financial stability from 

the London Interbank Offered Rate (LIBOR) since 2014. These concerns led the Federal Reserve to convene the Alternative Reference 

Rates Committee (or ARRC) at that time. The ARRC is a diverse 

group of private sector firms and institutions that has widespread 

support from the U.S. official sector. In addition to the Federal Reserve Board, the Consumer Financial Protection Bureau, the ComVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00126 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
123 

modity Futures Trading Commission (CFTC), the Federal Deposit 

Insurance Commission (FDIC), the Federal Housing Finance Authority, the Federal Reserve Bank of New York, the Office of the 

Comptroller of the Currency (OCC), the Office of Financial Research, the Securities and Exchange Commission (SEC), and the 

U.S. Treasury Department (U.S. Treasury) all act as ex officio 

members of the ARRC. The ARRC’s work in identifying the secured 

overnight financing rate (SOFR) as a recommended alternative to 

U.S. dollar LIBOR and developing a plan to promote use of SOFR 

on a voluntary basis has unquestionably been necessary in helping 

to make sure that the financial stability risks identified by the 

FSOC do not materialize. 

I have been greatly encouraged by the response of the private 

sector since SOFR began publication in April of this year. Even in 

this short period of time, we have already seen evidence that SOFR 

can and will be used by a wide range of market participants. The 

Chicago Mercantile Exchange is offering futures contracts on 

SOFR, and trading activity has already risen to above 5,000 contracts (or about $15 billion) per day with a total open interest of 

$75 billion. SOFR futures already have far more daily transactions 

underlying them than LIBOR. In addition, the London Clearing 

House group has begun offering clearing of SOFR swaps. And importantly, we have already seen two recent issuances of debt tied 

to SOFR. Both of these issuances were met with high demand and 

were oversubscribed, indicating that there is a robust pmt of the 

market that recognizes that SOFR instruments have value to them. 

There are several reasons that I believe we will see liquidity in 

SOFR instruments continue to grow. First, as a fully transactionsbased, International Organization of Securities Commissions compliant benchmark based on the overnight U.S. Treasury repo market—the largest rates market in the world—SOFR really does represent a robust alternative to U.S. dollar LIBOR. Because so many 

firms are active in the Treasury repo market, they naturally have 

incentives to trade SOFR instruments. Second, many market participants have come to realize that the risks the FSOC has pointed 

to in LIBOR are quite likely to materialize, and I believe they see 

that it is in their own interest to move away from LIBOR and toward SOFR. The ARRC and the official sector will ’need to continue 

to educate market participants about the risks to LIBOR, and work 

to make sure that this transition is a smooth one. 

Q.2. Foreign banks and prudential rules: I noticed that in the single-counterparty credit limit (SCCL) final rule, the Fed applied limitations on domestic bank holding companies that have $250 billion 

or more in total assets and the intermediate holding companies of 

foreign banks with at least $50 billion in total assets. And in the 

recent CCAR results, the Fed exempted three U.S. banks with assets between $50 billion and $100 billion, but continued to apply 

CCAR to the intermediate holding company of one foreign bank 

that has nearly $900 billion in total assets but only $86 billion in 

the U.S. 

Can you describe the philosophy guiding the Fed’s decisions to 

keep foreign banks’ U.S. holding companies covered by these important prudential rules? 

124 

A.2. In 2014, recognizing that the U.S. operations of foreign banking organizations (FBOs) had become more complex, interconnected, and concentrated, the Board adopted a final rule that 

established enhanced prudential standards for large U.S. bank 

holding companies (BHCs) and FBOs to help increase the resiliency 

of their operations. These standards include liquidity, risk management and capital, and require a FBO with a significant U.S. presence to establish an intermediate holding company (IHC) over its 

U.S. subsidiaries to facilitate consistent supervision and regulation 

of the U.S. operations of the foreign bank. The standards applied 

to the U.S. operations of FBOs are broadly consistent with the 

standards applicable to U.S. bank holding companies. However, the 

standards can also take into account the combined footprint of 

FBOs’ U.S. operations, including their branches and agencies. 

Accordingly, the 2018 final rule to implement single-counterparty 

credit limits (SCCL) for large U.S. bank holding companies tailors 

the application of SCCL to U.S. IHCs such that U.S. IHCs of similar size to U.S. BHCs covered under the rule are subject to the 

same SCCL, but the final rule also takes into account the IHC’s 

role as one portion of a significantly larger banking organization. 

Similarly, the Board’s annual Comprehensive Capital Analysis 

and Review (CCAR) applies more stringent standards to an IHC 

based on whether it is large and complex, meaning it (1) has average total consolidated assets over $250 billion or (2) has average 

total nonbank assets of $75 billion or more, and (3) is not a U.S. 

global systemically important firm. 

The Board monitors the impact of its regulations after implementation to assess whether the regulations continue to function as intended. In implementing enhanced prudential standards for FBOs 

with a large U.S. presence, the Board sought to ensure that FBOs 

hold capital and liquidity in the United States and have a risk 

management infrastructure commensurate with the risks in their 

U.S. operations. In general, FBOs with $50 billion in U.S. subsidiary assets are among the largest and most interconnected foreign banks operating in the United States. As a result of the IHC 

requirement, these films have become less fragmented, hold capital 

and liquidity buffers in the United States that align with their U.S. 

footprint, and operate on more equal regulatory footing with their 

domestic counterparts. I believe our current IHC framework with 

the current threshold is working well. 

Q.3. Volcker Rule: The policy behind the Volcker Rule is to reduce 

risky activities in banks, in particular high risk proprietary trading. I’ve long been a supporter of the Volcker Rule, and I think this 

is a worthy goal, as we never want banks to go back to that type 

of risky trading. The rule aims to achieve this in part by prohibiting banks from investing in hedge funds and private equity funds. 

I’ve heard, however, that the current definition has captured investments that seem far removed from the statute’s original concern—such as an incubator for women-run businesses—and prohibits bank investments in funds where banks are permitted to 

make the investment directly. The proposed rulemaking seems focused on easing compliance burdens that have been associated with 

the subjective intent test under the current rule, but it provides little clarity on the agencies’ thinking on the covered fund side. 

125 

Can you describe how the Federal Reserve is thinking about 

changes to the covered fund rules? 

A.3. The Board, along with the OCC, FDIC, CFTC, and SEC (the 

agencies) adopted regulations to implement section 13 of the BHC 

Act, the ‘‘Volcker Rule’’, in 2013. These regulations included a definition of ‘‘covered fund’’ that, in the agencies’ view, was consistent 

with the statutory purpose of the Volcker Rule to limit certain investment activities of banking entities. Subsequently, and based on 

experience with the Volcker Rule regulations, the agencies identified opportunities for improvement and proposed amendments to 

the Volcker Rule regulations in June 2018. 

The proposal requests comment on how to tailor the regulations 

governing a banking entity’s covered fund activities. For example, 

the proposal asks whether a different definition of ‘‘covered fund’’ 

would be appropriate. In addition, the proposal requests comment 

on potential exemptions for particular types of funds, or funds with 

particular characteristics. 

Since proposing the amendments in June, the agencies have held 

meetings with and received comments from interested patties regarding the treatment of covered funds. The agencies expect to 

meet with and receive comments from interested parties throughout the comment period, and will carefully consider each comment 

to determine whether any changes to the covered fund regulations 

would be appropriate. 

RESPONSES TO WRITTEN QUESTIONS OF 

SENATOR CORTEZ MASTO FROM JEROME H. POWELL 

Q.1. Home Mortgage Disclosure Act. I remain concerned about discrimination in mortgage lending, especially as we no longer have 

publicly available data on loan quality for 85 percent of the banks 

and credit unions. This means we need to rely on the staff of regulators to ensure banks comply with the Equal Credit Opportunity 

Act and the Fair Housing Act. 

How will you make sure that your bank examiners are looking 

at credit scores, loan-to-value ratios, interest rates, and other indicators of loan quality to ensure African Americans, Latinos, and 

single women are not getting lower quality mortgage loans? 

A.1. The Federal Reserve’s fair lending supervisory program reflects our commitment to promoting financial inclusion and ensuring that the financial institutions under our jurisdiction fully comply with applicable Federal consumer protection laws and regulations. For all State member banks, we enforce the Fair Housing 

Act, which means we can review all Federal Reserve-regulated institutions for potential discrimination in mortgages, including potential redlining, pricing, and underwriting discrimination. For 

State member banks of $10 billion dollars or less in assets, we also 

enforce the Equal Credit Opportunity Act, which means we can review these State member banks for potential discrimination in any 

credit product. Together, these laws prohibit discrimination on the 

basis of race, color, national origin, sex, religion, marital status, familial status, age, handicap/disability, receipt of public assistance, 

and the good faith exercise of rights under the Consumer Credit 

Protection Act (collectively, the ‘‘prohibited basis’’). 

126 

1See ‘‘Economic Growth, Regulatory Relief, and Consumer Protection Act’’, Public Law 115- 

174, S. 2155 §104(a) (May 24, 2018). 

We evaluate fair lending risk at every consumer compliance 

exam based on the risk factors set forth in the interagency fair 

lending examination procedures. Relevant to an evaluation of loan 

quality, those procedures include risk factors related to potential 

discrimination in pricing, underwriting, and steering. With respect 

to potential discrimination in the pricing or underwriting of mortgages, if warranted by risk factors, the Federal Reserve will request data beyond the public Home Mortgage Disclosure Act 

(HMDA) data, including any data related to relevant pricing or underwriting criteria, such as applicant interest rates and credit 

scores. This data can be requested from any Board-supervised institution, including the institutions that were exempted from reporting additional HMDA data by the Economic Growth, Regulatory 

Relief, and Consumer Protection Act (EGRRCPA). 1 The analysis 

then incorporates the additional data to determine whether applicants with similar characteristics received different pricing or underwriting outcomes on a prohibited basis (for example, on the 

basis of race), or whether legitimate pricing or underwriting criteria can explain the differences. 

At every examination, the Federal Reserve evaluates whether a 

lender might be discriminatorily steering consumers towards certain loans. An institution that offers a variety of lending products 

or product features, either through one channel or through multiple 

channels, may benefit consumers by offering greater choices and 

meeting the diverse needs of applicants. Greater product offerings 

and multiple channels, however, may also create a fair lending risk 

that applicants will be illegally steered to certain choices based on 

prohibited characteristics. The distinction between guiding consumers toward a specific product or feature and illegal steering 

centers on whether the institution did so on a prohibited basis, 

rather than based on an applicant’s needs or other legitimate factors. If warranted by risk factors, the Federal Reserve will request 

additional data, such as consumers’ credit scores and loan-to-value 

ratios, to determine that consumers would not have qualified for 

conventional loans. 

Q.2. Is it your expectation that the Fed will have the time and resources to proactively monitor these banks, without the required 

reporting in place? 

A.2. Provisions in the recently enacted bill, EGRRCPA, related to 

HMDA data collection requirements for certain institutions will not 

impact the Federal Reserve’s ability to fully evaluate the risk of 

mortgage pricing or underwriting discrimination. Although not included in the public HMDA data, if warranted by risk factors, the 

Federal Reserve will request any data related to relevant pricing 

and underwriting criteria, such as the interest rate and credit 

score. The Federal Reserve’s practice of requesting data relevant to 

pricing and underwriting criteria where warranted by risk factors 

predates EGRRCPA’s enactment, and the practice will continue. 

127 

2 In general, if a financial institution has assets exceeding $45 million and originated at least 

25 closed-end mortgage loans in each of the two preceding calendar years, or originated at least 

500 open-end lines of credit in each of the two preceding calendar years, it must meet the 

HMDA reporting requirements for its asset size. See ‘‘A Guide to HMDA Reporting: Getting it 

Right!’’, Federal Financial Institutions Examination Council (Eff. Jan. 1, 2018), https:// 

www.ffiec.gov/Hmda/pdf/2018guide.pdf. 

Q.3. How many additional staff will it take to proactively monitor 

the more than 5,000 banks now exempted from reporting requirements? 

A.3. With respect to HMDA, the Federal Reserve supervises approximately 800 State member banks. Recently enacted EGRRCPA 

exempts certain institutions from reporting the additional HMDA 

data fields required by the Dodd–Frank Wall Street Reform and 

Consumer Protection Act (Dodd–Frank Act). However, institutions 

exempted by EGRRCPA that meet HMDA’s data reporting threshold 2 must continue to report the HMDA data fields that are not 

the additional fields required by the Dodd–Frank Act. As noted 

above in response subpart (b), the Federal Reserve’s practice of requesting data relevant to pricing and underwriting criteria, where 

warranted by risk factors, predates EGRRCPA’s enactment, and 

the practice will continue. The Federal Reserve continually evaluates its workload and staffing needs to ensure that we are fulfilling 

our supervisory responsibilities. 

Q.4. Volcker—Postpone the Deadline for Comment. Congress passed 

the Volcker Rule to prevent taxpayer backed banks from gambling 

with insured deposits, destabilizing the financial system and failing 

or requiring bailouts. Recently, the SEC, CFTC, Federal Reserve, 

the OCC, and the FDIC have issued a new Volcker Rule proposal. 

However, I am concerned that regulators have only allowed for a 

60-day comment period to respond to a 689 page rule. That rule includes 342 enumerated questions, dozens of additional questions on 

the costs or benefits of aspects of the proposal, and invitations to 

comment on numerous technical concepts and provisions. A limited 

2 month comment period may not allow for outside groups, academics and researchers the full time needed to analyze the proposal. 

Will you extend the comment period by an additional 90 days? 

A.4. In early June 2018, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the 

Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodity Futures Trading Commission (together, the ‘‘agencies’’) proposed revisions to the rules implementing section 13 of the Bartle Holding Company Act (12 

U.S.C. §1851), also known as the Volcker Rule. The proposal’s comment period was for 60 days after publication in the Federal Register on July 17, 2018. On September 4, 2018, in response to requests from commenters, the agencies announced an extension of 

the comment period for an additional 30 days, until October 17, 

2018. The extension will allow interested persons additional time 

to analyze the proposal and prepare their comments. The agencies 

will carefully consider all comments in formulating the final rule. 

Q.5. Wage Stagnation. For the past 8 years, we have added jobs 

every quarter. However, wages are not going up. In fact, worker 

128 

3This pattern is evident in many other industrialized countries as well. Economists have been 

actively researching this issue, but thus far have not come to a consensus about the cause. Plausible explanations include the rapid advances in information and computing technologies during 

that period, increased international trade and outsourcing, and increased product market concentration among firms. But this is clearly an issue that warrants further study. 4 Brinker, Luke. ‘‘Thomas Picketty Slams Jeb Bush on Education and Inequality: ‘I Think 

There’s a Lot of Hypocrisy.’ ’’ Salon. March 11, 2015. Available at: https://www.salon.com/ 

2015/03/11/thomas-piketty-slams-jeb-bush-on-education-and-inequality-i-think-theres-a-lot-ofhypocrisy/. 

pay in the second quarter dropped nearly one percent below its 

first-quarter level, according to the PayScale Index, one measure of 

worker pay. When accounting for inflation, the drop is even steeper. Year-over-year, rising prices have eaten up still-modest pay 

gains for many workers, with the result that real wages fell 1.4 

percent from the prior year, according to PayScale. The drop was 

broad, with 80 percent of industries and two-thirds of metro areas 

affected. 

Meanwhile, many corporate profits have never been stronger. 

Banks are making record profits. Companies spent more than $480 

billion buying their own stocks. The increased profits are not going 

to workers’ salaries. Additionally, productivity has increased by 

73.7 percent from 1973 to 2016. 

Please expand on your views about the connection between 

wages and productivity. 

A.5. Over long periods of time, I believe that the best way to get 

faster sustainable wage growth (adjusted for inflation) is to raise 

productivity growth. The linkage between real wages and productivity is well-grounded in economic theory and both tended to rise 

together in the several decades following World War II. However, 

wage growth and productivity growth do not necessarily track 

closely over shorter periods, and even over a longer period of time, 

higher productivity growth does not guarantee a faster rise in real 

wages, as there are other factors that influence wages as well. This 

was evident between 1990 and 2010, when real wage growth for 

the average worker lagged despite a pickup in productivity 

growth. 3 That said, in recent years, both productivity growth and 

wage growth have been disappointing, and my sense is that efforts 

to boost productivity growth will be needed to support a faster sustained pace of real wage gains. 

Q.6. At the hearing, you said that investment in education and 

skills were ‘‘the single best’’ way to increase wages for workers. But 

many have found that connection to be overstated. For example, 

Thomas Picketty, author of Capitalism in the 21st Century, wrote 

in a blogpost: 4

‘‘there’s a lot of hypocrisy’ in the rhetoric of conservatives 

who condemn inequality while failing to support policies 

like an increased minimum wage and ramped-up infrastructure spending . . . You’re saying let’s tax the top and 

invest that money into education for all. 

[Jeb Bush] is a proponent of school choice, of giving schools 

vouchers so they can attend public school or private school, 

whatever they want. Is this a good solution in terms of 

dealing with what he calls the opportunity gap?’’ Ball asks 

Piketty. 

129 

5 Reeves, Richard V., and Katherine Guyot. ‘‘Black Women Are Earning More College Degrees, but That Alone Won’t Close Race Gaps’’. Brookings. December 4, 2017. Available at: 

https://www.brookings.edu/blog/social-mobility-memos/2017/12/04/black-women-are-earningmore-college-degrees-but-that-alone-wont-close-race-gaps. 

‘‘From what I can see, he doesn’t want to invest more resources into education. He just wants more competition 

. . . there’s limited evidence that this is working. And I 

think most of all what we need is to put more public resources in the education system. Again, if you look at the 

kind of school, high school, community college that middle 

social groups in America have access to, this has nothing 

to do with the very top schools and universities that some 

other groups have access to,’’ Piketty replies. ‘‘[I]f we want 

to have more growth in the future and more equitable 

growth in the future, we need to put more resources in the 

education available to the bottom 50 percent or 80 percent 

of America. So it’s not enough just say it, as Jeb Bush 

seems to be saying, but you need to act on it, and for this 

you need to invest resources,’’ he says. Asked about claims 

by Bush and other conservatives that a so called ‘‘skills 

gap’’ is responsible for the growth in inequality, Piketty 

dings that narrative as simplistic. ‘‘The minimum wage 

today is lower than it was 50 years ago, unions are very 

weak, so you need to increase the minimum wage in this 

country today. The views that $7 and hour is the most you 

can pay low-skilled worker in America today . . . I think 

is just wrong—it was more 50 years ago and there was no 

more unemployment 50 years ago than there is today. So 

I think we could increase the minimum wage,’’ Piketty 

says, adding that the U.S. should also invest in ‘‘high-productivity jobs that produce more than the minimum wage.’’ 

Education is important, Piketty acknowledges, but education alone is not enough to ameliorate inequality. ‘‘You 

need wage policy and you need education policy,’’ he says. 

‘‘And in order to have adequate education policy, you also 

need a proper tax policy so that you have the proper public 

resources to invest in these public services. Also you need 

infrastructure. Many of the public infrastructure in this 

country are not at the level of what the very developed 

should have. You cannot say, like many of the Republicans 

are saying, we can keep cutting tax on these top income 

groups who have already benefited a lot from growth and 

globalization over the past 30 years.’’ Data from the Survey of Consumer Finances indicates that, even when accounting for educational and racial disparities, black 

households headed by a college graduate are still less 

wealthy than less-educated white ones. 5

Please provide citations for your argument that education is the 

main driver for falling wages. 

How do you respond to analysis from other economists that say 

other reasons—tax policies, weakening unions, regulations that 

benefit the financial sector—are a stronger predictor for wage stagnation? 

130 

6 Claudia Goldin and Lawrence F. Katz, ‘‘The Race Between Education and Technology’’, 

Belknap Press, 2010. 7David Autor, ‘‘The Polarization of Job Opportunities in the U.S. Labor Market: Implications 

for Employment and Earnings’’ Brookings, April 2010, https://www.brookings.edu/wp-content/ 

uploads/2016/06/04jobslautor.pdf. 8 A recent paper by Robert Valletta estimates that the wage premium for a college-educated 

worker (relative to a high school graduate) rose from about 30 percent in 1980 to 57 percent 

in 2010 and has leveled off since then. See Robett Valetta, ‘‘Recent Flattening in the Higher 

Education Wage Premium: Polarization, Skill Downgrading, or Both?’’ Working Paper No. 2016- 

17, Federal Reserve Bank of San Francisco, August 2016. 9Mary C. Daly, Bart Hobijn, and Joseph H. Pedtke, ‘‘Disappointing Facts About the Black– 

White Wage Gap’’, FRBSF Economic Letter No. 2017-26, Federal Reserve Bank of San Francisco. 

Can you further elaborate on the wage inequities between racial 

and educational disparities? 

A.6. I would like to start by noting two good references detailing 

the important link between education and wages are: The Race Between Education and Technology by Claudia Goldin and Lawrence 

F. Katz; 6 and ‘‘The Polarization of Job Opportunities in the U.S. 

Labor Market: Implications for Employment and Earnings’’ by 

David Autor. 7 The book by Goldin and Katz traces the coevolution 

of educational attainment and the wage structure in the United 

States through the twentieth century. They argue, in particular, 

that the demand for educated workers outpaced the supply beginning in about 1980, and that this supply–demand imbalance resulted in a rise in the wage premium for college-educated workers. 

In addition, both resources note that increases in educational attainment have not kept pace with rising educational returns, suggesting that the slowing pace of educational attainment has contributed to the rising gap between college and high school earnings. 

And, although the college wage premium has leveled off in recent 

years, it remains large. 8

Of course, education is not the only factor that influences wage 

growth. For example, the paper by David Autor points out that the 

rise in the relative earnings of college graduates reflected both rising real earnings for college workers and falling real earnings for 

noncollege workers. He attributes these trends to the polarization 

of job growth, with job opportunities concentrated in relatively 

high-skill, high-wage jobs and low-skill, low-wage jobs, and cites 

the automation of routine work and the increased globalization of 

labor markets through trade and outsourcing as the primary influences on this trend. He acknowledges that changes in labor market 

institutions, in particular, weaker labor unions and a falling real 

minimum wage, may also play a role but argues that these factors 

are less important, in part because these wage trends are evident 

in many industrialized countries. 

With regard to racial disparities in wages, research by economists at the Federal Reserve Bank of San Francisco shows that African American men and women earn persistently lower wages 

compared with their white counterparts and that these gaps cannot 

be fully explained by differences in age, education, job type, or location. 9 I agree with their conclusion that these disparities are troubling and warrant greater attention by policymakers. 

Q.7. Regulation. Chair Powell, at your nomination hearing, you 

told me that you supported strong consumer protections. 

131 

10See 24 CFR part 100. 

Please name at least five issues areas where the Federal Reserve 

will continue to lead in consumer protection. 

A.7. The Federal Reserve has a strong commitment to promoting 

a fair and transparent financial services marketplace. We conduct 

consumer-focused supervision and enforcement; conduct research 

and policy analysis; develop and maintain relationships with a 

broad and diverse set of stakeholders; and work to foster community development. 

Our consumer protection efforts include investigating consumer 

complaints, assuring consumers’ fair and equal access to credit and 

treatment in financial markets, assessing the trends shaping consumers’ financial situations, and offering consumer help via tools 

and resources developed by Reserve Banks and other agencies. Examples of the range of our consumer protection priorities and efforts are described below. 

As part of our supervisory outreach, our Reserve Banks have various consumer and community advisory councils. Additionally, the 

Board meets semiannually with its Community Advisory Council 

(CAC) as well as with a wide range of consumer and community 

groups throughout the year. The CAC is a diverse group of experts 

and representatives of consumer and community development organizations and interests. This important line of communication provides the Board with broad perspectives on the economic circumstances and financial services needs of consumers and communities, with a particular focus on the concerns of low- and moderate-income populations. 

With regard to our enforcement of fair lending laws and unfair 

or deceptive acts or practices (UDAP) laws, our supervisory program is rigorous and we are clear in our communications with 

firms about our expectations when we find weakness in their compliance management systems or violations of consumer laws. When 

we find consumer hmm, we make sure that consumers are provided 

any appropriate restitution, and when the situations warrant, we 

also impose civil money penalties. 

Fair lending violations may cause significant consumer harm as 

well as legal, financial, and reputational risk to the institution. The 

Federal fair lending laws—the Equal Credit Opportunity Act 

(ECOA) and the Fair Housing Act (FHA)—prohibit discrimination 

in credit transactions, including transactions related to residential 

real estate. The ECOA, which is implemented by the Board’s Regulation B (12 CFR part 202), prohibits discrimination in any aspect 

of a credit transaction. It applies to any extension of credit, including residential real estate lending and extensions of credit to small 

businesses, corporations, partnerships, and trusts. Lending acts 

and practices that are specifically prohibited, permitted, or required are described in the regulation. 

Official staff interpretations of the regulation are contained in 

Supplement I to the regulation. The FHA, which is implemented by 

regulations promulgated by the U.S. Department of Housing and 

Urban Development, 10 prohibits discrimination in all aspects of 

residential real estate-related transactions. 

132 

The Board is committed to ensuring that every bank it supervises complies fully with Federal financial consumer protection 

laws, including the fair lending laws. A specialized Fair Lending 

Enforcement Section at the Board works closely with Reserve Bank 

staff to provide guidance on fair lending matters and to ensure that 

the fair lending laws are enforced consistently and rigorously 

throughout the Federal Reserve System (System). Fair lending risk 

is evaluated at every consumer compliance examination. Additionally, examiners may conduct fair lending reviews outside of the 

usual supervisory cycle, if warranted by elevated risk. 

Section 5 of the Federal Trade Commission Act (FTC Act) prohibits UDAP and applies to all persons engaged in commerce, including banks, and the law extends to bank arrangements with 

third parties. The Federal Reserve has the authority to take appropriate supervisory or enforcement action when unfair or deceptive 

acts or practices are discovered at institutions under the Federal 

Reserve’s jurisdiction, regardless of asset size. We apply longstanding standards when weighing the need to take supervisory 

and enforcement actions and when seeking to ensure that unfair or 

deceptive practices do not recur. Examples of practices the Federal 

Reserve has found to be unfair or deceptive include certain practices related to overdrafts and student financial products and services. 

With respect to these and other UDAP issues, the Federal Reserve’s enforcement actions have collectively benefited hundreds of 

thousands of consumers and provided millions of dollars in restitution. 

In addition to carrying out enforcement actions, we provide training, direction and support to Reserve Bank examiners in assessing 

institutions’ compliance with applicable laws and regulations. 

On the consumer level, the System also has a robust process for 

responding to consumer complaints about the banks we supervise. 

We investigate every complaint of an institution under our supervisory jurisdiction and refer them to the appropriate agency if it involves an institution that we do not supervise. Reserve Banks must 

respond in writing in a timely manner. 

For the financial institutions we regulate, we develop and offer 

guidance to help reduce risk to consumers that supports our desire 

to ensure equitable treatment of all consumers, including those in 

underserved and economically vulnerable populations. 

We collect and analyze risk data and trends in the financial services sector affecting consumers and the financial institutions that 

we supervise, and we identify emerging consumer protection issues 

and promote compliance by highlighting these areas in publications, webinars, and other outreach. Examples include our recently 

launched Consumer Compliance Supervision Bulletin, which provides to banks and others high-level summaries of pertinent supervisory observations related to consumer protections, as well as our 

Consumer Compliance Outlook, a System publication focused on 

consumer compliance issues, and its companion webinar series, 

Outlook Live, both of which are targeted to the industry to support 

banks’ compliance efforts. 

Another example is our annual Survey of Household Economic 

Decisions (SHED). The SHED is designed to enhance our underVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00136 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
133 

11 Bosley, Catherine. ‘‘Summers Warns Next U.S. Recession Could Outlast Previous One’’, 

Bloomberg. February 28, 2018. Available at: https://www.bloomberg.com/news/articles/2018- 

02-28/summers-warns-next-u-s-recession-could-outlast-the-previous-one. 

standing of how adults in the United States are faring financially, 

and the results of the survey are posted on our public website. 

Other areas include research particularly focused on the housing 

market, small business access to credit, and rural economic development issues. 

Through a number of events and on a variety of matters, we provide outreach to consumer advocacy and community development 

organizations that outlines the risks in consumer financial product 

markets. Examples of such programs have focused on auto lending, 

FinTech/marketplace lending, and student lending. 

Q.8. Monetary Policy. If the Fed usually cuts the Federal funds 

rate by 5 percentage points to fight a recession and the neutral 

rate is around 2.5 percent, what steps can the Federal Reserve currently take to offset a recession? 11 Expand the balance sheet by 

buying treasuries? 

A.8. The possibility that the Federal funds rate could be constrained by the effective lower bound in future economic downturns 

appears larger than in the past because of an apparent decline in 

the neutral rate of interest in the United States and abroad. Several developments could have contributed to such a decline, including slower growth in the working-age populations of many countries, smaller productivity gains in the advanced economies, a decreased propensity to spend in the wake of the financial crises 

around the world since the late 1990s, and perhaps a paucity of attractive capital projects worldwide. 

In any case, the Federal Reserve has a number of tools that it 

can use in the event that the Federal funds rate is constrained by 

the effective lower bound. One such tool is explicit forward guidance about the path of future policy. By announcing that it intends 

to keep short-term interest rates lower for longer than might have 

otherwise been expected, the Federal Reserve can put significant 

downward pressure on longer-term borrowing rates for American 

families and businesses. Another tool is large-scale asset purchases, which can also put downward pressure on longer-term borrowing rates and ease financial conditions. These tools have been 

an important part of the Federal Reserve’s efforts to support economic recovery over the past decade. Studies have found that these 

tools eased financial conditions and helped spur growth in demand 

for goods and services, lower the unemployment rate, and prevent 

inflation from falling further below the Federal Open Market Committee’s (FOMC) 2 percent objective. The Federal Reserve is prepared to use its full range of tools if future economic conditions 

were to warrant a more accommodative monetary policy than can 

be achieved solely by reducing the Federal funds rate. 

Q.9. Many Federal Reserve officials—including most recently outgoing New York Fed President Bill Dudley—have talked about the 

need for Congress to beef up fiscal stabilizers that can react automatically to a downturn. 

134 

12 ‘‘Officials on Record: Automatic Stabilizers’’, Dudley, William C. ‘‘Speech: Important Choices 

for the Federal Reserve in the Years Ahead’’, The Federal Reserve in the Years Ahead. April 18, 

2018. Available at: https://www.newyorkfed.org/newsevents/speeches/2018/dud180418a. 

Do you agree that Congress should be working on this? If so, 

which stabilizers do you think are most effective? 12

A.9. The current monetary policy tools available to the Federal Reserve can provide significant accommodation in the event of an economic downturn, although we recognize that there are limits stemming importantly from the effective lower bound on the nominal 

Federal funds rate. As a matter of prudent planning, we continue 

to evaluate potential monetary policy options in advance of an episode in which our primary policy tool is constrained by the effective 

lower bound. Since monetary policy is not a panacea, countercyclical fiscal policy actions are a potentially important tool in addressing a future economic downturn. In particular, automatic fiscal stabilizers have been and continue to be helpful in providing 

timely accommodation and thus tempering the extent of a downturn. A range of fiscal policy tools and approaches could enhance 

their effectiveness in helping to provide cyclical stability to the 

economy. However, it is appropriate that the details of fiscal policy 

changes be left to the Congress and the Administration. 

Q.10. At your most recent press conference you said—‘‘we can’t be 

too attached to these unobservable variables.’’ If that’s the case, do 

you think it is possible that the United States could sustain a long 

period of unemployment at 3 percent or even lower? Japan’s unemployment has fallen to 2.7 percent and Germany is at 3.4 percent. 

A.10. Monetary policy necessarily involves making judgments 

about aspects of the economy that cannot be measured directly but 

instead must be inferred. One of those aspects is the level of the 

unemployment rate that can be sustained in the longer term without generating either upward or downward pressure on inflation. 

That level is sometimes referred to as the natural rate of unemployment. Economic modelers have only a limited ability to estimate the natural rate of unemployment at any given moment; 

moreover, there is every reason to believe that the natural rate can 

and does change over time. For both of these reasons, policymakers 

must always be vigilant in looking for evidence that might cause 

them to revise their existing estimates of parameters such as the 

natural rate of unemployment. 

As of today, most estimates of the natural rate of unemployment 

in the United States range between 4 percent and 5 percent. Other 

countries will have different rates of unemployment that are sustainable in the longer run (sometimes markedly so), depending on 

the characteristics of the workforces in those countries (such as age 

and education), the geographic mobility of jobs and workers, and 

structural labor market policies, to name a few factors. 

Q.11. At the last hearing you described the risks to the economy 

as balanced, but it seems like the Fed has much more room to 

tighten policy—by raising rates and running down the balance 

sheet—than it does to loosen policy. Doesn’t that change the balance of risks? If you hike interest rates too fast, you have limited 

tools to address an economic slowdown. If you hike too slowly, you 

have ample tools to address the overheating. 

135 

13 CNBC. ‘‘Jerome Powell: I’m a big supporter of diversity.’’ November 28, 2017. Available at: 

https://www.cnbc.com/video/2017/11/28/jerome-powell-im-a-big-supporter-of-diversity.html. 14Sebastian, Shawn. ‘‘Fed Up Blasts Process, Outcome of Richmond Federal Reserve Presidential Appointment’’, The Center for Popular Democracy. Available at: https:// 

populardemocracy.org/news-and-publications/fed-blasts-process-outcome-richmond-federal-reserve-presidential-appointment. 15 Condon, Christopher. ‘‘Fed Documents Show Powell’s Hand in Richmond President Search’’, 

Bloomberg. July 16, 2018. Available at: https://www.bloomberg.com/news/articles/2018-07-16/ 

fed-documents-show-powell-s-hand-in-richmond-president-search. 

A.11. The FOMC recognizes that the effective lower bound (ELB) 

on the Federal funds rate can impose a significant constraint on 

the conduct of monetary policy. This is one of the reasons that the 

Committee has normalized the stance of monetary policy at a gradual pace during the current economic expansion. That said, the 

Federal Reserve has other tools at its disposal to provide economic 

stimulus when the Federal funds rate is constrained by the ELB, 

including explicit forward guidance about the path of Federal funds 

rate and large-scale asset purchases. Moreover, with strong labor 

market conditions, inflation close to 2 percent, and the level of the 

Federal funds rate at a bit below 2 percent, the risk of returning 

to the ELB has diminished substantially since earlier in the recovery. Overall, the FOMC currently sees the risks to its economic 

outlook as roughly balanced. 

History has shown that moving interest rates either too quickly 

or too slowly can lead to bad economic outcomes. If the FOMC 

raises interest rates too rapidly, the economy could weaken and inflation could run persistently below the FOMC’s objective. Conversely, there are risks associated with raising interest rates too 

slowly. Waiting too long to remove policy accommodation could 

cause inflation expectations to begin ratcheting up, driving actual 

inflation higher and making it harder to control. Moreover, the 

combination of persistently low interest rates and strong labor 

market conditions could lead to undesirable increases in leverage 

and other financial excesses. While the Federal Reserve has tools 

to address such developments, these circumstances could require 

the FOMC to raise interest rates rapidly, which could risk disrupting financial markets and push the economy into recession. 

Q.12. Fed Governance, Diversity, and the San Francisco Fed Vacancy. At your confirmation hearing, you expressed your support 

for more diversity among the Federal Reserve’s leadership, saying, 

‘‘We make better decisions when we have diverse voices around the 

table, and that’s something we’re very committed to at the Federal 

Reserve.’’ 13 You also commented on the role that the Board of Governors plays in approving new Reserve Bank presidents, and assured the Senate Banking Committee that there is always a ‘‘diverse pool’’ in searching for candidates to fill those positions. However, the December selection of Thomas Barkin as the president of 

the Richmond Fed gives reason for doubt. 14 Press reports note that 

you were very involved in vetting candidates. 15

Then, in April, John Williams was announced as the new New 

York Fed president. A source close to the process said that the New 

York Fed search committee just could not find qualified candidates 

who were interested in this position, even though community 

136 

16Guida, Victoria, and Aubree Eliza Weaver. ‘‘In Defense of the NY Fed Search Committee’’, 

Politico. March 30, 2018. Available at: https://www.politico.com/newsletters/morning-money/ 

2018/03/30/in-defense-of-the-ny-fed-search-committee-154624. Guida, Victoria. ‘‘Warren Leads 

Crusade for Diversity at Fed’’, Politico. April 2, 2018. Available at: https://www.politico.com/ 

story/2018/04/02/federal-reserve-diversity-elizabeth-warren-452122. 17For more information about the FRBNY’s president search timeline, see https:// 

www.newyorkfed.org/aboutthefed/presidential-search-timeline. 

groups had given a list of qualified and diverse candidates to the 

New York Fed board in January. 16

Can you explain why these candidates were not considered? 

A.12. It is crucial for us to conduct search processes that are transparent and open to public input, and that encourage interest and 

applications from qualified candidates with as wide a variety of 

personal and professional backgrounds as possible. The Federal Reserve System needs such diversity to be fully effective in discharging its responsibilities, and we have observed that better decisions are made when there are many different perspectives represented around the table. I am firmly committed to conducting 

each president search in as open a manner as possible. However, 

I also recognize the importance of maintaining the privacy of candidates and the confidentiality of the composition of the candidate 

pool in order to encourage as many qualified individuals to apply 

as possible. Therefore, it is not appropriate for me to comment on 

the qualification of individual candidates. 

During the recent Reserve Bank president searches, the search 

committees proactively sought out candidates from a variety of 

sources. More specifically, in addition to engaging the search firm 

Spencer Stuart, the Federal Reserve Bank of New York (FRBNY) 

search committee engaged Bridge Partners, which has a specific expertise in the identification of diverse talent. The FRBNY search 

committee itself also undertook an extensive program of outreach 

intended to solicit input and views from a range of constituencies 

across the district: 

• The search committee sent approximately 400 letters soliciting 

feedback on the attributes that would enable success in the 

role of FRBNY president, as well as specific names for consideration. 

• Members of the search committee met with the FRBNY’s 

standing advisory committees, including the Advisory Council 

on Small Business and Agriculture, the Community Advisory 

Group (comprised of nonprofit organizations), the Economic 

Advisory Panel (comprised of academic economists), and the 

Upstate New York Regional Advisory Board. 

• The search committee also held two meetings at the FRBNY 

with ad hoc groups of invitees, one focused on labor and advocacy organizations and the other on business and industry. 

Out of these large candidate pools, the search committees identified candidates who not only had the desired experiences and key 

attributes but also confirmed their interests in the president positions. The FRBNY search committee, at the conclusion of its search 

process, published the process timeline and the characteristics of 

the candidate pool. 17

137 

18 Campbell, Dakin. ‘‘Goldman Sacks Teaming up With Former Honeywell CEO Cote To 

Strike an Unusual Acquisition’’, Business Insider. Accessed July 16, 2018. Available at: http:// 

www.businessinsider.com/goldman-sachs-and-former-honeywell-ceo-cote-teaming-up-to-buy-an-industrial-company-filing-2018-5. 19 Haedtler, Jordan. ‘‘Why Do Former Golden Sachs Bankers Keep Landing Top Slots at the 

Federal Reserve?’’ The Nation. November 30, 2015. Available at: https://www.thenation.eom/ 

article/why-do-former-goldman-sachs-bankers-keep-landing-top-slots-at-the-federal-reserve/. Bernstein, Jake. ‘‘The Carmen Segarra Tapes’’, ProPublica. November 17, 2014. Available at: 

https://www.propublica.org/article/the-carmen-segarra-tapes. 20For more information about our policies governing the directors, see https:// 

www.federalreserve.gov/aboutthefed/directors/policy-governing-directors.htm. 21Fed Up. ‘‘New Report Analyzes Diversity at the Federal Reserve in 2018’’, The Center for 

Popular Democracy. February 14, 2018. Available at: https://populardemocracy.org/blog/newreport-analyzes-diversity-federal-reserve-2018. 

Q.13. Former Honeywell CEO David Cote served as a banker-elected member of the New York Fed board and search committee, but 

abruptly stepped down in mid-March. We later learned he had resigned this position to take a job with Goldman Sachs. 18 According 

to the New York Fed, the search committee had already settled on 

John Williams by the time that Cote resigned from the board. The 

outgoing New York Fed president was formerly Goldman Sachs’ 

chief economist, and there have been many reported instances of 

an overly cozy relationship between the Fed and Goldman Sachs, 

including tapes that leaked in 2014 showing that the New York 

Fed was very lenient in supervising Goldman. 19

Do you think it is appropriate that one of the people responsible 

for choosing a top Wall Street regulating position was negotiating 

a job with Goldman Sachs at the very moment he was making the 

decision about who the next New York Fed president should be? 

Does this event raise concerns that the financial industry has too 

much influence on regional Reserve Banks boards? 

A.13. The process for selecting a Federal Reserve Bank president 

is set forth in the Federal Reserve Act. Subject to the approval of 

the Board of Governors, a Reserve Bank president is appointed by 

that Bank’s Class Band Class C directors. These are the directors 

who are not affiliated with banks or other entities supervised by 

the Federal Reserve. Class A directors, who are bankers, are not 

involved in the search process. 

Since 2014, Mr. Cote served on the board of the FRBNY and on 

the search committee as a Class B director, representing the public. Mr. Cote brought to the board his background in the manufacturing and represented the industry while serving as a director. 

Mr. Cote promptly resigned his position on the FRBNY board of directors, recognizing that pursuing new business opportunities in 

the banking sector would affect his eligibility to serve as a Class 

B director. 20

Q.14. A recent analysis by the Center for Popular Democracy found 

that although there has been an increase in the gender and racial 

diversity of the Federal Reserve Bank’s directors, the Fed is still 

falling short of true public representativeness. 21 Williams’ selection 

has opened up a vacancy at the San Francisco Federal Reserve 

Bank. The twelfth Federal Reserve district is the largest and most 

diverse in the country, including a significant Latino population. 

Latinos comprise 30 percent of the district. There has never in the 

Fed’s history been a Latino Federal Open Markets Committee participant, either as a governor or as a Reserve Bank president. 

138 

22For more information about the San Francisco search, go to: https://www.frbsf.org/our-district/press/news-releases/2018/mary-c-daly-named-federal-reserve-bank-of-san-francisco-president-and-chief-executive-officer/?utmlsource=frbsf-home-in-the-news&utmlmedium=frbsf& 

utmlcampaign=in-the-news. 23 Baker, Dean, ‘‘Measuring the Inflation Rate: Is Housing Different?’’ Center for Economic 

and Policy Research. June 2018. Available at: http://cepr.net/publications/reports/measuringthe-inflation-rate-is-housing-different. 

Do you think it would be valuable for you and your colleagues 

to hear the perspective of a Latino FOMC participant? 

A.14. As I have said, we make better decisions when we have diverse voices around the table, and that is something we are very 

committed to at the Federal Reserve. The Federal Reserve seeks diversity in personal and professional backgrounds to be more effective in discharging its responsibilities. We value a broad representation of perspectives, and are working hard towards greater diversity at all levels of the Federal Reserve. Recognizing that the appointment of a Reserve Bank president is, as a legal matter, the 

responsibility of the Class B and Class C directors who are by definition not affiliated with financial institutions in the district, we at 

the Board worked closely with the search committee to ensure a 

strong and transparent process that identified a broad and diverse 

slate of qualified candidates. 

As you know, the Federal Reserve Bank of San Francisco 

(FRBSF) recently selected Mary Daly as its next president. The 

processes of the FRBSF search committee were fair, transparent, 

and inclusive. 22 The FRBSF search committee included eligible directors from its board who brought diverse backgrounds and experiences to the process. Further, the search committee partnered 

with Diversified Search, the largest female-founded and owned firm 

that specializes in identifying candidates from diverse backgrounds. 

The search committee carried out an extensive outreach program, 

both in person and virtually, with a range of constituencies across 

the district, to gain their input on the search process, obtain their 

views on the most important attributes for the Bank president role, 

and solicit their recommendations of potential candidates. 

At the conclusion of its search process, the FRBSF published additional information about the outreach conducted, timeline, and 

characteristics of the candidate pool. The FRBSF noted that of 283 

prospective candidates 33 percent were from a minority background and 33 percent were female. 

Q.15. Inflation Target. In a paper that was recently presented to 

Atlanta Fed President Raphael Bostic, economist Dean Baker argued that the Fed should consider removing the shelter component 

from its core inflation indexes. 23 The reason is that higher housing 

costs, particularly in a handful of metropolitan areas, are significantly outpacing other measures of inflation—and that these increases stem from a lack of supply. Baker further argues that continued interest rate increases from the Fed might have the perverse effect of sapping housing construction, thereby exacerbating 

the very problem (rising inflation) that the Fed is trying to address. 

What do you make of this analysis? 

A.15. We interpret the Federal Reserve’s price-stability mandate as 

applying to a broad measure of the price of goods and services purchased by consumers. Shelter makes up a large component of conVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00142 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
139 

sumers’ expenditures, and a price index that excludes shelter 

would provide a highly incomplete measure of the cost of living. 

To be sure, because monetary policymakers need to be forward 

looking in setting policy, we also pay attention to less-comprehensive inflation measures to help gauge whether a particular inflation 

movement is likely to persist. For example, we examine price indexes excluding food and energy items, as food and energy prices 

often exhibit large transitory movements. But idiosyncratic price 

movements are by no means limited to food and energy, and they 

could well occur in shelter prices at times; we need to be attentive 

to whether such movements might be providing a misleading signal 

about inflation’s likely future course. My fellow policymakers and 

I will continue to factor such judgments into our analyses, even as 

we remember that overall consumer price inflation must be the ultimate focus of our policy. 

Q.16. Immigration. Neel Kashkari, the chief of the Minneapolis 

Fed, stated that immigration has a net benefit on economic growth. 

He said slowing down immigration may slow down job growth and 

the U.S. economy as a whole. 

Do you agree with President Kashkari? 

A.16. Immigration is an important contributor to the rise in the 

U.S. population, accounting for roughly one-half of population 

growth annually. And population growth, in turn, affects the 

growth rate of the labor force as well as the growth of the overall 

economy. Thus, from an economic growth standpoint, reduced immigration would result in lower population growth and thus, all 

else equal, slower trend economic growth. However, as you know, 

immigration policy is for Congress and the Administration to decide. 

Q.17. SIFI Designation. As a voting member of FSOC, you and 

your fellow members are tasked with the mission of identifying and 

responding to risks that threaten the financial stability of the 

United States, particularly in the shadowy nonbank ecosystem that 

required numerous massive bailouts following the 2008 financial 

crisis. Despite the large number of bail-outs conferred, only four 

nonbanks were designated as systematically significant by the 

FSOC. 

As you considering whether to reduce monitoring and oversight 

of one of those institutions? 

What about the financial state or inherent systemic risk of large 

nonbank institutions has changed since FSOC made the considerations that warrants removing any enhanced prudential oversight? 

A.17. The financial crisis showed that the distress of large and systemic nonbank financial companies could imperil the financial stability of the United States, ultimately putting the American economy at risk. The Dodd–Frank Wall Street Reform and Consumer 

Protection Act (Dodd–Frank Act) gave regulators new tools to address this problem, including authorizing the Financial Stability 

Oversight Council (FSOC) to determine that a nonbank financial 

company’s material financial distress would threaten the financial 

stability of the United States. If such a determination is made, 

such firms are then subject to supervision by the Federal Reserve 

Board (Board). The Dodd–Frank Act authorizes the Board, in conVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00143 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
140 

24Larkin, Michael. ‘‘All Banks Clear Stress Test—But This Big Name’s Payout Plan at Risk’’, 

Investor’s Business Daily. June 21, 2018. Available at: https://www.investors.com/news/stresstest-results-federal-reserve-bank-dividends-buybacks//. 25 Bloomberg. ‘‘Wells Fargo Plans $24.5 billion in Stock Buybacks After Passing Fed Stress 

Test’’. Los Angeles Times. June 28, 2018. Available at: http://www.latimes.com/business/la-fiwells-fargo-stock-buyback-20180628-story.html. 

sultation with the FSOC, to establish enhanced prudential requirements and to supervise nonbank financial companies that have 

been designated as systemically important. Further, the Dodd– 

Frank Act requires the FSOC to reevaluate each determination of 

a nonbank financial institution as systemically important on at 

least an annual basis. The FSOC is also responsible for making the 

determination to retain or rescind the designation of a nonbank financial institution. 

Financial vulnerabilities, such as high leverage levels and maturity mismatches between assets and liabilities, are not at the elevated levels they were prior to the crisis. Regulators have developed a deeper understanding of the ways in which nonbank financial institutions differ from banks, particularly in terms of their 

vulnerability to runs and the potential systemic impact this may 

have on the U.S. financial system. Further, several nonbank financial institutions have made significant changes to the organizational structure of their firms as well as the markets that they participate in, which has further reduced their overall risk to the U.S. 

financial system. 

However, the regulatory community has learned from the experience of the financial crisis that it is important to focus on potential 

regulatory gaps and to deal with vulnerabilities that may build in 

nonbank financial institutions before the risks become material. In 

this context, it is important to continue to monitor large nonbank 

financial firms to ensure that, should they encounter distress, the 

functioning of the broader economy is not threatened. Finally, the 

possibility of de-designation provides an incentive for designated 

firms to significantly reduce their systemic footprint. 

Q.18. Stock Buybacks. The Fed’s 2018 CCAR cycle allowed the 22 

largest banks to payout $170 billion in dividends and buybacks, 

around a quarter more than 2017. Banks subject to the CCAR process are likewise paying out close to 102 percent in buybacks and 

dividends as a percentage of forecasted earnings. 24

In the wake of the Federal Reserve’s annual stress testing, Wells 

Fargo announced plans to buy back up to $24.5 billion in stock, and 

boost its quarterly dividend. Twenty-eight other firms were also allowed to proceed with additional proposals to boost stock buybacks 

and dividends. 25

In your testimony before the Committee, you noted that investments in training and education were ‘‘the single best thing we can 

do to have a productive workforce.’’ 

What does research suggest about whether dividends and 

buybacks raise wages for American workers? 

Does the Fed have any researching suggesting the impact on economic growth if a larger percentage of bank earnings instead went 

to raise wages of nonmanagerial and/or frontline bank workers? 

A.18. Productivity growth is a key determinant of wage growth, 

and investments in new capital equipment or innovative techVerDate Nov 24 2008 14:11 Dec 18, 2018 Jkt 046629 PO 00000 Frm 00144 Fmt 6602 Sfmt 6602 L:\HEARINGS 2018\07-17 ZZDISTILL\71718.TXT JASON
141 

1For the survey and report, see the Federal Reserve Board’s Survey of Household Economics 

and Decision Making at www.federalreserve.gov/consumerscommunities/shed.htm. 

nologies are important factors for improving productivity growth. 

Similarly, increased worker compensation can be a factor in encouraging individuals to join or remain in the labor force and to develop new skills, which can further increase productivity and wage 

growth. However, comparing the economic effects of these uses of 

a company’s earnings to the eventual economic effects of stock 

buybacks is difficult because we do not know where the gains from 

buybacks will ultimately turn up. In particular, when a company 

buys back its shares or pays higher dividends, the resources do not 

disappear. Rather, they are redistributed to other uses in the economy. For instance, shareholders may decide to invest the windfall 

in another company, which may in turn make productivity-enhancing investments. Or they may decide to spend the windfall on goods 

and services that are produced by other companies, who may in 

turn hire new workers. In these ways, stock repurchases would 

also be likely to boost economic growth. Ultimately, companies 

themselves are the best judges of what to do with their profits, 

whether it is to invest in their business or increase returns to 

shareholders through dividends or share buybacks. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR JONES 

FROM JEROME H. POWELL 

Q.1. In the Federal Reserve’s 2018 Report on the Economic WellBeing of U.S. Households, the report finds that 40 percent of Americans do not have the sources to cover an unexpected $400 expense. 

While the number of Americans responding in this manner has 

shrunk since 2013, as noted in the report, it is still an alarmingly 

high number. 

The report notes that the most common response among those 

who could not cover an expense is to place the purchase on a credit 

card. 

Are there broader economic implications of such a reliance on potentially high-priced consumer credit? 

A.1. According to the survey, conducted in the fourth quarter of 

2017, 18 percent of U.S. adults report that they would pay a hypothetical $400 emergency expense with a credit card that they then 

pay off over time. 1 In the initial survey in 2013, this fraction was 

17 percent. The fraction of adults who said they would not be able 

to meet a $400 expense by any means declined to 12 percent in 

2017 from 19 percent in 2013. 

Broader implications of such responses are difficult to gauge. The 

costs of financing such an expense would add financial burden on 

these households, relative to paying in cash. However, for some 

households, such credit access may act as a relief valve of sorts, allowing them to meet the emergency or avoiding even costlier forms 

of credit such as payday loans. 

Q.2. Does the Federal Reserve have further context on this response—how does the number of Americans unable to cover a $400 

expense compare to previous decades, or to other advanced economies? 

142 

2For more information, see reports and research on the Federal Reserve Board’s Survey of 

Consumer Finance at www.federalreserve.gov/econres/scfindex.htm. 3Faster Payments Task Force, ‘‘Final Report Part One: The Faster Payments Task Force Approach’’, January 2017, and ‘‘Final Report Part Two: A Call To Action’’, July 2017. Available 

at https://fasterpaymentstaskforce.org/. 

A.2. The Federal Reserve first asked how individuals would handle 

a $400 unexpected expense in 2013. While we do not have an exact 

comparison in prior decades or in other countries, the Federal Reserve Board’s triennial Survey of Consumer Finances (SCP) reports 

that the share of households with easily accessible savings remains 

low and has changed little in recent decades. 2 Liquid savings, such 

as cash, checking or saving accounts, are the least costly and easiest assets to use for unexpected expenses. The 2016 SCP reports 

that nearly half of all families did not have $3,000 in liquid savings, almost the same fraction since 1989 in inflation-adjusted 

terms. 

Q.3. Does this inability to cover expenses increase dramatically 

across certain groups for example, seniors, young people, or minorities? 

A.3. Yes, financial security and the ability to cover expenses, differs across demographic groups. As one example, in 2017, one-quarter of white adults without education beyond a high school degree 

did not expect to pay their current month’s bills in full. Among African Americans and Hispanics with the same education level, that 

fraction was 41 percent and 35 percent respectively. 

Financial security is more common with more education, but a 

gap by race and ethnicity remains. As a second example, only half 

of young adults (under the age of 30) would use cash or its equivalent to cover an unexpected $400 expense, versus 57 percent of 

middle-aged adults (ages 30 to 64) and 71 percent of seniors (age 

65 and older). Even with such differences by age, race, and education, the economic recovery has improved the finances across 

many groups. 

Q.4. I am concerned that for Americans that live paycheck to paycheck, the United States’ payment system can, at times, fall short. 

In particular, I believe there is great need for faster payments, including quicker access to consumer funds after deposit. When consumers do not access to their own funds, they often resort to and 

rely on high-cost products that are outside of the traditional banking system. 

The Federal Reserve has acknowledged the need to help foster a 

faster payments system with its work and creation of the Faster 

Payments Task Force. What are the next steps and future priorities for the Task Force? 

A.4. In July 2017, the Faster Payments Task Force (FPTF) concluded its work upon release of its final report. The FPTF’s Final 

Report reflected the task force’s perspectives on challenges and opportunities with implementing faster payments in the United 

States, outlined its recommendations for next steps, and included 

the proposals and assessments for the 16 participants that opted 

to be included in the final report. 3 The FPTF recommendations 

identified the need for ongoing industry collaboration to address infrastructure gaps; to develop models for governance, rules, and 

143 

4The desired outcomes are outlined in the Federal Reserve System’s ‘‘Strategies for Improving 

the U.S. Payment System’’, January 26, 2015. Available at https:// 

fedpaymentsimprovement.org/wp-content/uploads/strategies-improving-us-payment-system.pdf. 

The refreshed strategies and tactics are outlined in the Federal Reserve System’s ‘‘Strategies 

for Improving the U.S. Payment System: Federal Reserve Next Steps in the Payments Improvement Journey’’, September 6, 2017. Available at https://fedpaymentsimprovement.org/wp-content/uploads/next-step-payments-journey.pdf. 

standards; and to consider actions and investments that will contribute to a healthy and sustainable payments ecosystem. A number of recommendations called for Federal Reserve support to facilitate this ongoing collaboration. 

Following up on the work of the FPTF and other efforts to advance the Federal Reserve’s desired outcomes (focused on speed, security, efficiency, international payments, and collaboration) for the 

payment system, the Federal Reserve published, in September 

2017, a paper presenting refreshed strategies and tactics that the 

Federal Reserve is employing in collaboration with payment system 

stakeholders. 4

The Federal Reserve kicked off these refreshed strategies and 

tactics in the summer of 2017, by facilitating the industry’s work 

to address the FPTF recommendations related to governance, directories, rules, standards, and regulations. In addition, consistent 

with the FPTF recommendations, the Federal Reserve has been assessing the needs and gaps to enabling 24x7x365 settlement in 

support of a future ubiquitous real-time retail payments environment. 

Further, the Federal Reserve has started to explore and assess 

the need, if any, for any other operational roles to support ubiquitous, real-time retail payments. These efforts are being pursued 

in alignment with Federal Reserve’s longstanding principles and 

criteria for the provision of payment services. 

Q.5. As you know, new accounting standards, based on a ‘‘current 

expected credit loss’’ (CECL) model, developed by the Financial Accounting Standards Board (FASB) will go into effect in 2020. While 

the new accounting standards underwent multiple years of study, 

the implementation of these standards will result in one of the 

larger changes to banking accounting in recent memory. 

The CECL standard is likely to affect bank capital in uncertain 

and potentially volatile ways, especially as banks begin the transition process to this new accounting standard. Did FASB consult 

with the Federal Reserve for how these changes might impact bank 

capital? 

A.5. The Federal Reserve Board (Board) along with the other U.S. 

Federal financial institution regulatory agencies have supported 

the Financial Accounting Standards Board’s (FASB) efforts to improve the accounting for credit losses and provide financial statement users with more decision-useful information about the expected credits losses on loans and certain other financial instruments. 

Throughout the development of the current expected credit loss 

(CECL), the FASB conducted extensive outreach with a diverse 

group of stakeholders, including the Federal Reserve System. 

Stakeholders provided input and feedback through the public comment letters and participation in public forums. The FASB did not 

144 

5 83 Federal Register 22312 (May 14, 2018). 

specifically consult the Board regarding CECL’s impact to bank 

capital since their mandate is to establish and improve financial 

accounting and reporting standards to provide decision-useful information to investors and other users of financial reports. 

In response to CECL, the Board, with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance 

Corporation (FDIC) (together, ‘‘the agencies’’), recently issued a 

joint proposal that would address the forthcoming changes. In particular, the proposal would provide firms the option to phase in the 

day-one regulatory capital effects of CECL over a 3-year period. 

The agencies intend for this transition provision to address films’ 

challenges in capital planning for CECL implementation, particularly due to the uncertainty of economic conditions at the time a 

film adopts CECL. 

The agencies are currently reviewing comments to the proposal 

in preparation for finalizing it. In addition, the agencies will continue to monitor the effects of CECL implementation on regulatory 

capital and bank lending practices to help determine whether any 

further changes to the capital rules are warranted. 

Q.6. Is the Federal Reserve taking into these rule changes as it 

continues to implement capital rules created by the Dodd–Frank financial reform law? 

A.6. The Board is indeed taking into consideration the impact of 

CECL in connection with the Board’s ongoing regulatory and supervisory functions. For example, the agencies, earlier this year 

issued a joint proposal entitled Implementation and Transition of 

the Current Expected Credit Losses Methodology for Allowances 

and Related Adjustments to the Regulatory Capital Rules and Conforming Amendments to Other Regulations. 5 In the joint proposal, 

the agencies proposed to amend the regulatory capital rules of the 

agencies to address changes to U.S. generally accepted accounting 

principles (GAAP) resulting from the FASB’s issuance of CECL. 

The proposal would provide firms subject to the capital rules with 

the option to phase in, over a 3-year period, the day-one adverse 

regulatory capital effects of CECL that may result from the adoption of the new accounting standard. This transition period is intended to address the potential challenges in planning for CECL 

implementation, including the uncertainty of economic conditions 

at the time that a firm adopts CECL. In addition, the proposal 

identifies certain credit loss allowances under the new accounting 

standard that would be eligible for inclusion in regulatory capital. 

The agencies are currently reviewing comments received from 

the public on the proposal. The Board will continue to monitor the 

effects of CECL implementation on firms supervised by the Board 

and on the U.S. financial system. 

Q.7. As the CECL requirements go into effect in 2020, the first 

tests of how they impact bank capital may come during annual 

CCAR process. 

Will the Federal Reserve be taking into account these rule 

changes as it undertakes the 2019 and 2020 CCAR process? 

145 

A.7. In May 2018, the Board published a joint notice of proposed 

rulemaking with the OCC and FDIC to address changes to U.S. 

GAAP associated with CECL, issued by FASB in June 2016. Under 

the proposal, the Board would not incorporate CECL into the supervisory stress tests, and would not require a firm to incorporate 

CECL into its stress tests, until the 2020 cycle. If a banking organization were to adopt CECL for the first time in 2021, it would 

not be required to include provisioning for credit losses under the 

new standard until the 2021 stress test cycle. 

This proposal avoids ‘‘pulling forward’’ the effect of CECL, by 

aligning the dates that firms are expected to include CECL in their 

comprehensive capital analysis and review projections with the actual date of implementation for those firms implementing in 2020 

and 2021. 

In advance of CECL implementation, the Federal Reserve is considering feedback received during outreach discussions with industry representatives, developing approaches for incorporating provision for credit losses in its supervisory models, and preparing for 

parallel testing of those models. 

146 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

MONETARY POLICY REPORT TO THE CONGRESS DATED JULY 13, 2018 


71718001.eps
147 


71718002.eps

LETIER OF T RANSMITIAL 

BOARD Of GOVER~O S Of TilE 

FEDERAL R ESI:RVE Sl'STEM 

Washington, O.C, July 13,2018 

THE RES O£~• Of TilE SeN,m 

THE SPEAKER OF THE HollSE OF REPRESENTATIVES 

The Board of Governors is pleased to submit its Monet(lr)' Policy Repqtt pursuant to 

section 28 of the Federal Resen·e Act. 

Sincerely. 

Jerome H. P01vell, Chairman 
148 


71718003.eps

STATEMENT ON LONGER-RUN GOALS AND M ONETARY Poucv STRATEGY 

Adopted ~ffectiv~ January 24, 2012; as amended effeclile /anuary 30, 2018 

The Federnl Open Market Committee (FOMC) is firmly committed to fulfilling its statutory 

mandate from the Congress of promoting maximum employment, stable prices, and moderate 

long-term interest rates The Committee seeks !O explain its monetary policy decisions to the public 

as clearly as possible. Such clarity facilitates well-informed decisionmaking by households and 

businesses, r<'duces economic and financialuncertaint)', ncre~ses the elfectil'eness of monetary 

policy, and enhances transparency and accountability, which are essential in a democr.uic society. 

Inflation. employment, and long-term interest rnte$ fluctuate o1·er time in response to economic and 

financial disturbances Moreover, monetary policy actions tend to influence economic activity and 

prices with a Jag. Therefore. the Committee's policy decisions reflect its longer-run goals, its mediumterm outlook, and its assessments of the balance of risks. including risks to the financial system that 

could impede the attainment of the Committee's goals 

The inflation rate 01·er the longer run is primarily determined by monetary policy, and hence the 

Committee has the ability to specify a longer-run goal for inflation. The Committeereaftirms its 

judgment that infiation at the rate of 2 percent, as measured by the annual change in the price 

index for personal consumption expenditures is most consistent o1·er the longer run 11~th the 

Federal Reserve's Statutory mandate. The Committee would be concerned if inflation were nmning 

persistently above or below this objective. Communicating this symmetric inflation goal clearly to the 

public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability 

and moderate long-term interest rates and enhancing the Committee's ability to promote maximum 

employment in the face of significant economic disturbances Tile maximum level of employment 

is largely determined by nonmonetary factors that aft'ectthc structure and dynamics of the labor 

market. These factors may change owr time and may not be dir<'Ctly measurable. Consequently, 

it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy 

decisions must be informed by assessments of the maximum level of employment. recoguizing that 

such assessments are n«essarily uncertain and subject to revision. The Committee considers a 

wide range of indicators in making these assessment~ Information about Committee participants' 

estimates of the longer-run normal rntes of output growth and unemployment is published four 

times per year in the FOMC's Summar)• of Economic Projections. For example, in the most 

recent projections. the median of FOMC participants' estimates of the longer-run normal rate of 

unemployment was 4.6 percent. 

In setting monetary policy. the Committee seeks to mitigate de1~ations of inflation from its 

longer-run goal and de1•iations of employment from the Committee's assessments of its maximum 

level. TI!ese objectil'es 3re generally complementar)'. Howel'er, under circumstances in which the 

Commiuee judges that the objeeti1oes are not complementary. it follows a balanced approach in 

promoting them. taking into account the magnitude of the deviations and the potentially dift'erent 

time horizons 01•er which empiO}~ nt and inflation are projected to return to levels judged 

consistent with its mandate. 

The Committee intends to reaftirm these principles and to make adjustments as appropriate at its 

annual organizational meeting each January. 
149 


71718004.eps

CONTENTS 

Summary ..•.•• .•... .. •. . .. . . .. .. .•..•. .. . . .. .•... . .. .•. .•• 1 

Economic and Financial Developments .. .. .. ... .. .. .. .. ... .. .. .. . .. .. ..... .. .. . 1 

Monetary Policy . . ..... .......... . 

Special Topics .. ... _ .. . . .. ..... .. .. ... . 2 

Part 1: Recent Economic and Financial Developments .... . .. .. . . . .... 5 

Domestic Developments. . . . . . . . . . . . . . . 5 

Financial Developments.... .. . . .. .. .. . • . .. .. .. ..... ... 23 

International Developments .. ...... .. .......... ......... .. ..... .... ..... .. .. 30 

Part 2: Monetary Policy . .. .. .......•..•.... .. ......... .......• 35 

Part 3: Summary of Economic Projections ......................... 47 

The Outlook for Economic Activity.. . .. • . .. .. .. .. . • . .. . • .. . .. . . . . 48 

The Outlook for Inflation ............ .... ..... .. .... .. ... ...... . .. 50 

Appropriate Monetary Policy . .. .. ... .... ....... ...... ... .. ..... .... ..... .. .. 51 

Uncertainty and Risk~. . . ................ ........... ..... ........ . ... 51 

Abbreviations .............. .. . .. . .. . ..... . .... .. . .... .. .. . . 63 

List of Boxes 

The labor Force Participation Rate for Prime-Age Individuals. .. . . . . . . . • . . . . • . . . 8 

The Recent Rise in Oil Prices . . . . . . . . . . . . . . . . . . . . . . . .. ..... .... ..... .. .. 16 

Developments Related to financial Stability. . . . . . . . . . . . .. 26 

Complexities of •\\onetary Policy Rules.. . . . 37 

Interest on Reserves and Its Importance for Monetary Policy. . . . . . .. •. . ..•. ...•. .. .. 44 

forecast Uncertainty_ . . . . . . . . . . . . . . 62 

Non: This rtporl refle<ls information thai was publicly available as of noon EDT on july 12, 2018. 

nlessotherwise~Ated, thetinleseriesin the figures extend through. ford.>ilr d.>t.l, /uly II, 2018; formonthlyd.>t.l. 

June 2018; and. for quarterly dat.l. 2018:QI.In bar charts. except as noted. the change for a i1 n period is Aleasured to 

i~ final quartet from the final quarter oflhe pre<eding period. 

~=orr!pl'SI6¥1dl4,n.:«'ch.Jil.he$.\P>OOII'dbandlflt0ow~s..nloln6.'-:t;«tpcoductsd S.Sf>OoN~~llC<~ndbf~ai~IA'SM!d 

fl>,•b<toli<<•sollc•.,.brd<llo.«i.Ccp,~ON I~PI)o.lcn<>Wct!llC.•<l'lslcoci~ PC!cb.l....t'eti:s"';t-.AII~""""'­

~~~nd'or~'ingiB~<.fv;lCtocinp.ll'tMtprohl>ilednittloul ~<.li:wl~dS&POow~~ltC.Forfi'IOo't 

~on-nrofs.\POowkww:ilndicflllC'$inclktsplt.as.e 'h'"W.spd;A:etn.SSM~~·€'Jcd~dSund.Nd fbor'sr~ 

I<M«>UC.">dD>w-~••..,;;,o«tv-ciO..-T•-Hcl6ni>UC.""-'"'!.! O...-I""'"UC.D>w_T_ 

~UC.thtu.-ifii'ICI:tsi'IOI'thtifi!Wd~li«nsmrrw~Mf)'«P~ion Y>:A~r.l'*-~ -.i«lasiO!ht~·d'.vrt.'~kl 

XW:Uf~l(~lflt~~CC~S«tord\Mit~IIOrtptt'Sti'C..-ndnei:her~f>Oo< ndic~ lC.I)ro!.v~lr~~ 

llC.I.hl:ir~il:tsncw~thitd!Nit)'lic~~ll~~.!ny ihl~b.lny~~orif(~d¥Jy~orr:ht'd$itd;ldPc;lt/ll.'c~ 

falisJ.n'Ailllhtbc».'hrrolMRfsmt'SM'Idlt'S~tb ~A:IIq-,•nottttwt~DTCCSol~llCI"'i)fiiJfoii:u~WII 

bl-~iOI'o~t~t·ft!OtSOt~iti¥1)'0TCC~I'Icludtdin~p.blic¥oiol\.~d~\"<IV!t~nd.in~f'.tte.W!IO CCc:r~d 

.,,.....,t>."""'"'''Y~""-.,.'""""""'~~--1<!>1""-«"""'"'""os""'"'""'""""cl>. ti'Dig~.u'ldopp:ttlric')'(0>6tin~v.1tttlhis~iaca 
150 


71718005.eps

SuMMARY 

Economic activity increased a1 a solid pace 

over 1 he firs I half of 20 IS. and 1 he labor 

market has cominued 10 strengthen. In8a1ion 

has moved up, and in May, I he mosl recent 

period for which data are a1-ailable. inflation 

measured on a 12-monlh basis was a linle 

above the Federal Open Markel Commiuee's 

(FOMC) longer-mn object h-e of 2 pen:enl, 

boosted by a sizable increase in energy prices. 

In I his economic em;ronment the Commiuee 

judged thai currem and prospective economic 

conditions called for a further gradual removal 

of monetary policy accommodation. In line 

with that judgment, the FOMC raised the 

1arge1 for the federal funds rale 111;ce in the 

first half of 2018, bringing i11o a range of 

1% 10 2 pe~ttnt. 

Economic and Financial 

Developments 

The labor market. The labor market has 

continued 10 s1rengthe11. Over the first 

six momhs of 2018, payrolls increased an 

average of 215,000 per month, which is 

somewhat above the a1-erage pace of 180.000 

per month in 2017 and is considerably faster 

than whal is needed. on average. 10 provide 

jobs for new em ranis imo I he labor force. 

The unempi0)1nenl ra[e edged down from 

4.1 pe~ttnl in December 10 4.0 percem in June. 

which is about Y, percentage point below the 

median of FOMC parlicipanls' estimates of 

its longer-run normal I mi. Other measures 

of labor milization were consis1e111 with a 

tight labor market However. hourly labor 

compensation gro111h l1as been moderate. 

likely held down in pari by the weak pace of 

productivity growth in recent years. 

Inflation. Consumer price inflation, as 

measured by the 12-monlh pen:entagechange 

in the price index for personal consumption 

expenditures. n101'ed up from a linle below 

the FOMC's objective of 2 percent a11heend 

of last year to 2.3 percent in May. boosted by 

a si1.able increase in consumer energy prices. 

The 12-monlh measure of in8a1ion thai 

excludes food and energy items (so-called core 

inflation). which historically has been a beuer 

indicator of where overall inflation will be in 

the fmure than the Iota! figure, was 2 percent 

in May. This reading was '/:percentage point 

above where il had been 12 momhs earlier. as 

the unusually low readings from last year were 

not repealed. Measures of longer-run inflation 

expectations hal'e been generally stable. 

Economic growth. Real gross domestic product 

(GOP) is reponed 10 ha1-e increased at an 

annual tale of 2 percent in the first quarter 

of 2018, and recent indicators suggest thai 

economic growth stepped up in the second 

quaner. Gains in consumer spending slowed 

early in the year. btlllhey rebounded in 

the spring. supported by strong job gains, 

nxenl and pas! increases in household 

weahh, fal'orable consumer sentiment and 

higher disposable income due in par110 the 

implementation of 1he Tax OtiS and Jobs Act 

Business im'eSimenl growth has remained 

robust, and indexes of business sentiment hai'C 

been strong. Foreign economic growth has 

remained solid, and nel ex pons had a roughly 

neutral elfecl on real U.S. GOP groWih in the 

first quaner. However, acti,;ly in the housing 

market has leveled otr this year. 

Financial conditions. Domestic financial 

conditions for businesses and households 

hal'e generally continued 10 support economic 

gro111h. After rising steadily through 2017, 

broad measures of equity prices are modeslly 

higher. on balance. from their levels all he end 

of last year amid some bouts of heightened 

volatility in financial market~ While longterm Treasury )ields, mortgage rates, and 

yields on corporate bonds hal'e risen so far 

this year, longer-term interest rates remain 

low by historical standard~ and corporate 

bond issuance has cominued a1 a moderate 

pace. Moreover, mos11ypes of consumer loans 
151 


71718006.eps

2 SUMI\1\RY 

remained 11idely al'<lilable for hoLLSeholds 11ith 

strong crcditwonhiness. and credit provided by 

commercial banks continued to expand. The 

foreign exchange value of the U.S. dollar has 

appredated somewhat a,o:~ nstt ecurrenc es 

of our trading partners this year, but it 

remains below its le1<el at the start of 2017. 

Foreign financial conditions remain generally 

supportiw of growth despite recent increases 

in financial stn.'SS in several emerging market 

economies 

Financial stabilit)'· The U.S. financial system 

remains substantially more resilient than 

during the decade before the financial crisis. 

Asset valuations continue to be elevmed 

despite declines since the end of2017 in the 

forward price-to-eamings ratio of equities and 

the prices of corporate bonds. In the pril'ate 

nonfinancial sector. borrowing among highly 

le1<ered and lower-rated businesses remains 

elevated, although the ratio of household 

debt to disposable income continues to be 

moderate. Vulnerabilities stemming from 

le1•erage in the financial sector remain low, 

reflecting in part strong capital positions 

at banks. whereas some measures of hedge 

fund leverage ha1<e increased. Vulnerabilities 

associated with maturity and liquidity 

transformation among banks, insurance 

companies money market mutual funds, 

and asset managers remain below levels that 

generally prevailed before 2008. 

Monetary Policy 

Interest rate policy. Over 1he first half of2018, 

the FOMC has continued to gradually increase 

the targ~t range for the fedml funds rat~. 

Specifically, the Committee decided to raise 

the target range for the federal funds rate at 

its meetings in March and June. bringing it 

to the current range of ~ to 2 percent. The 

decisions to increase the target range for the 

federal funds rate reflected the economy"s 

continued progress toward the Committee"s 

objectil<es of maximum employment and price 

s1ability. E1<en with these policy rate increases. 

the stance of monetary policy remains 

accommodatil'e. thereby supporting mong 

labor market conditions and a sustained return 

to 2 percent inflation. 

The FOMCexpects lhat further gradual 

increases in the target range for the federal 

funds rate will be consistent 111th a sustained 

expansion of economic acti1•ity. strong labor 

market conditions. and inflation near the 

Committee·s S)1nmetric 2 percent objectil<e 

over the medium 1erm. Consistent with this 

outlook, in the most recent Summary of 

Economic Projections (SEP). which was 

compiled at the time of the June FOMC 

meeting, the median of participants" 

assessments for the appropriate Jerel for 

the federal funds rate rises gradt1ally over 

the period from 2018to 2020 and stands 

somewhat above lhe median projection for 

its longer-run level by the end of 2019 and 

through 2020. (The June SEP is presented 

in Part 3 of this report.) Howe1·er. as the 

Committee has continued to emphasize, the 

timing and size of fmure adjustments to the 

target range for the federal funds rate will 

depend on the Committee ·s assessment of 

realized and expected economic conditions 

relative to its maximum-employment objectil'e 

and its symmetric 2 percent inflation objective. 

Balance sheet policy. The FOMC has 

continued to implement the balance sheet 

normalization proo,ram described in the 

Addendum to the Policy Normalization 

Principles and Plans that the Committee issued 

about a year ago. Specifically. the FOMC has 

been reducing its holdings ofTreasury and 

agency securities by decreasing. in a gradual 

and predictable manner, the reill\'eStment 

of principal payments it recei1<es from these 

securities 

Special Topics 

Prime-age labor forct participation. Labor 

force participation rates (LFPRs) for men and 

women beh,·een 25 and 54 years old- that is. 

the share of these indi1iduals either working 

or actively seeking work- trended lower 
152 


71718007.eps

between 2000 and 2013. Those trends likely 

reflect numerous factors, including a long-run 

decline in the demand for workers with lower 

levels of education and an increase in the 

share of the population with some form of 

disability. By contrast, the prime-age LFPR 

has increased notably since 2013, and the 

share of nonparticipants who report wanting 

a job remains above pre-recession levels. Thus. 

some continuation of the recent increase in 

the prime-age LFPR may be possible if labor 

demand remains strong. (See the box '"The 

Labor Force Panicipation Rate for Prime-Age 

Individuals'" in Part 1.) 

Oil prices. Oil prices ha1•e climbed rapidly 

over the past year, reflecting both supply and 

demand factors. Although higher oil prices 

are likely to restrain household consumption 

in the United States, much of the negative 

eft"ect on GDP from lo\\~r consumer spending 

is likely to be offset by increased production 

and investment in the growing U.S. oil sector. 

Consequently, higher oil prices now imply 

much less of a net overall drag on the economy 

than they did in the past, although they will 

continue to have important distributional 

effects. The negative ciTect of upward moves 

in oil prices should get smaller still as U.S. oil 

production gro11~ and net oil imports decline 

further. (See the box ''The Recent Rise in Oil 

Prices" in Pan 1.) 

Monetary policy rules. Monetary policymakers 

consider a wide range of intbrmation on 

current economic conditions and the outlook 

MONETARY I'OIICY Rri'ORT: lUll' 2013 3 

when deciding on a policy stance they deem 

most likely to foster the FOMCs statutory 

mandate of ma.,imum employment and stable 

prices. They also routinely consult monetary 

policy rules that connect prescriptions for the 

policy interest rate with variables associated 

with the dual mandate. The use of such rules 

requires. among other considerations. careful 

judgments about the choice and measurement 

of the inputs into the rules such as estimates 

of the neutral interest rate, which are highly 

uncertain. (See the box "Complexities of 

Monetary Policy Rules" in Part 2.) 

Interest on resmes. The payment of interest 

on reserves- balances held by banks in 

their accounts at the Federal Reserve-is an 

essential tool for implementing monetary 

policy because it helps anchor the federal 

funds rate within the FOMC"s target range. 

This tool has permitted the FOMC to achiere 

a gradual increase in the federal funds rate in 

combination with a gradual reduction in the 

Fed's securities holdings and in the supply 

of reserve balances. The FOMC judged that 

remo1~ng monetary policy accommodation 

through first raising the federal funds rate 

and then beginning to shrink the balance 

sheet would best contribute to achie1•ing and 

maintaining maximum employment and 

price stability without causing dislocations in 

financial markets or institutions that could put 

the ~anomie expansion at risk. (See the box 

'·Interest on Reserves and Its Importance for 

Monetary Policy" in Part 2.) 
153 


71718008.eps

PART 1 

RECENT ECONOMIC AND FINANCIAL D EVELOPMENTS 

Domestic Developments 

The labor market strengthened further 

during the first half of the year .. . 

Labor market conditi<>ns have continued to 

strengthen so far in 2018. According to the 

Bureau of Labor Statistics (BLS). gains in 

total nonfarm payroll emplo)~ ent averaged 

215,000 per month over the first half of the 

year. That pace is up from the average monthly 

pace of job gains in 2017 and is considerabl)• 

faster than what is needed to provide jobs for 

new entrants into the labor force (figure I ).

1 

Indeed, the unemployment rate edged down 

from 4.1 percent in Docember to 4.0 percent 

in June (figure 2). This rJtc is below all 

Federal Open Market Committee(FOMC) 

participants' estimates of its longer-run 

normal level and is about Y, percentage point 

below the median of those estimates.' The 

unemployment rate in June is close to the lows 

last reached in 2000. 

The labor force participation rate (LFPR), 

which is the share of individuals aged 16 

and older who are either working or actively 

looking tbr II'Ork, ~~~s 62.9 percent in June 

and has changed little, on net, since late 

2013 (figure3). The aging of the population 

is an important contributor to a downward 

trend in the o1·erall participation rate. In 

particular, members of the baby-boom 

cohort are increasingly mO\fing into their 

retirement years. a time 1111en labor force 

participation is typically low. Indeed, the 

share of the civilian population aged 65 

and over in the United States climbed from 

16 percent in 2000 to 19 percent in 2017 and 

is projected to rise to 24 percent by 2026. 

Given this trend, the Hat trajectory of the 

t. Monohlyjobgain< inolte mngeof tJO.OOOoo 

160.0Cl0 areconsis1e-m i1h.an un~-hanged ui:'K'mploymcnt 

ratt and an unchanged Ia boor forct panicipation r.ue. 

1. Set I he Summary cr£.conomic Proje\"1ions in Pan J 

of this repon. 

I. N~1 cb-.lngc in p3)TOIJ C'mp!oymml 

!fJIJ l:IIO 2011 2012 lOll XII~ rots 2016 roUllliS 
154 


71718009.eps

6 PART 1: R£aNTECOKO.IliCA-'OflNAKCW.0Ml0f'MENTS 

2. Me3Sun:s of labor undcruliliZ3tion 

_,, 

-II 

_,. 

-12 

- 10 

- I 

I• I I 

~•o :Gl6 llllS 

Non.: ll~a.'llln:tm..~.klCIJ~\'\Ias:a~/.!(lhtbh.Jc(OI\Y lJ..4~10C.al~~~~~'\1"'\'d:«S.asa 

~"fmm~tJflht bbt'f'l«~~~~~utt"r$.~~·~fta~of~·~~ud:t.'liv.~•f»a:eflollcuTtl'ltlylootiflsl'or•orl. 

l).~theybcliC\ tiO~ilCI\'ii~bb,I.,\S~wl~\"d~~~~ w.-btdi(Jih,:bborfot«,tii~Oflh::bl:« 

!Ot«pllb~~~~·~"dool:b;~f«<.'t M~-ty.:tl(t,(d•'(lltcru:eCIXIOtb.:'bbot~."'11'lt~¥en-aibbkb•cd! aodfs) ('~(IJ 

for:ajobia~~ lmotll.h:s.U-4~N ~~l'J~~~·~",_.'<f~m.p.\seCIW~W,on~~:Xf«~\'CQlll'ni(~asa 

r-~ofehrbborl««plui;all~X!kb.'\1-..~-n..lb:~l:w~s•f'C'OO:'of'~R\~as&-fino."b)·lb:~~o4 

'""""""""'"'"' ~J:tt &wll'a!ofb.\xSietlo;'HbKmTAIIIl)OO.. 

3. Labor ron.~ padicip.11ioll rates :llld 

emp!oymcnt·to-popu13.1ion r.:nio 

!IXl6 l009 ))ll lOIS JJ\8 

Non:Tkdaa:tl!ll.'ldtly.Tk~b.Xc'fon. ~'On!t. 

KlptTI.~dtfltp:tflllbOOa~H 10St Tht bb.."f btt~ 

~-lhrftiiPio)1llml ~ra'tioa:t~'T\~cllkp.'9Q~ 

~lh:ldcr..:t. 

SdHl; BomMidl*'T~ iafl.ll'l:J~tlo:$,. 

LFJ'R during the pasl few years is consistenl 

wilh s1reng1hening labor markel cond on~ 

Similarly, 1he LFPR for individuals bel ween 

25 and 54 years old- which is much less 

sensilil'e to population aging- has been rising 

for I he past se1-eral )'ears.(The box ''The 

Labor Force Participation Rate for PrimeAge lndil'iduals" examines I he prospecls for 

further increases in participation for these 

individual&) The employment -to-population 

ratio for indi1;duals 16 and over- the share 

of I he total population who are workingwas 60.4 pem:nt in June and has been 

gradually increasing $ince 2011 , refletting the 

combination of I he declining unemployment 

rate and the ftal LFPR. 

Other indicators are also consistenl 1111h 

a slrong labor market. As reported in 1he 

Job Openings and Labor Turnover Sumy 

(JOLTS), I he r.ne of job openings has 

remained quite elevated' The r.11e of quits has 

J. lndetd.ohtnumber of job openings nowabouo 

matches: the number of unemployed indl\ iduals. 
155 


71718010.eps

s1ayed high in the JOLTS, an indication that 

workers are able to suc-cessfully switch jobs 

when they wish to. In addition. the JOLTS 

layoft' rate has been low. and the number of 

people filing initial claims for unemployment 

insuranoe benefits has <remained near its 

lowest le1'el in decades Other sun·ey evidence 

indicates that households perceive jobs as 

plentiful and that businesses see vacancies as 

hard to fill. Another indicator, the share of 

workers who are worki'ng part time but would 

prefer to be employed full time-which is part 

of the U-6 measure of Iaber underutilization 

from the BLS-fell further in the forst six 

months of the year and now stands close to its 

pre-recession le1•el (as shown in figure 2) . 

. . . and unemployment rates have fallen 

for all major demographic groups 

The continued decline in the unemployment 

rate has been reftected in the experiences of 

multiple racial and ethr1ic groups (figure 4). 

Tile unemplo)'nent rates for blacks or 

African Americans and Hispanics tend to 

rise considerably more than rates for whites 

and Asians during recessions but decline 

4. Uncnlploymct\1 r3te by race and cthnicity 

- 8bd:orA.fnc.AIIICidl 

lOIO 

MONeTARY POLICY Rtl'ORT: lUll' 2013 7 

..... 

- IS 

- 16 

- I• 

- ll 

- 10 

- s 

- 6 

-. 

lOIS 

1\.orP. U~~t.'qlkiJ.l':(:fllra! ~IOCllm..~'tiJas2~oflk bl:uk«e.P.:tSOC!So.f»s.:'tlhrtirily isid<a6 r.:das I¢orl.airloe'lly"kof 

tl!l} tlo.~ lll<~bw~a p..'f'iod~fbusioo:s$r~as6..'6o."dbrlk 21:~8:art:IGof~Rc:st:.wb. 

Soc.m: ur~oll.abxStMtis:ia -i)K1 l'rr\tla tKs.. 
156 


71718011.eps

8 PART 1: R£aNTECOKO.\liCA-'OflNAKCW.0MlOf'MENTS 

The Labor Force Participation Rate for Prime-Age Individuals 

The "'"'all labor force pMicipalion rale ILFPRJ 11M 

generallyb..n vending lower since 2000, and ~>bile 

1he aging ol1he babr-boom generalion iniO reliremenl 

ages !)lovides an importanl reason for lh.ll decline, 

it is not the only reason. Al'tOlher contJibuting !actor, 

as shown in •igure A. is 1ha1 lhe LFPRs of f)li~age 

men and '"'men (lhose f>et;,ton 25 and 54 )~•~ 

old) vended lowe< lhrough 2013 Mn though primeage LFPRs are largely unaffected by lhe aging oi 

lhe population: The prime-age male LFPR has heen 

declining fO< ~'decades, and lhe pri......,ge female 

LFPR has drilled lcMe< sinoe 2000 afle< a multidecolde 

in<reast. Ne.'(l(lheless, f)limNge LFPRs ha'-e n101-ed 

up nolably and consi~en1ly since 2013, as imp<01·ing 

labor mad:et condilions have drawn some incf .. iduals 

back inlo lhe labor force ancJ encouragod Olhe<s 00110 

1,,., ... These rece<ll increa<es in lhe prime-age lFPR. 

in lhe conlexl oilhe i<lnger-run !rend decline, fdiselhe 

que<~ion of hcnv much addilionalscope !here is for 

iurthef increases in prime-age labor force participalion. 

To gauge whether furthet increa<es are P"'Sible, a 

useful ~arting point is unde<>landing lhe faclors behind 

the longer-run decline in the p<in1e-age LFPR, aslhese 

iactoo ma)' limit additional increasg ii they continue 

to exet1 some downward pressure. Ore f.(lctor ~· 

be a secular decline in lhe demand for """'"' "ilh 

""''" levels of edocolion. Indeed, "shcnm in figure 6, lhe long-run decline< in prime-age LFPR ;re much 

larger ;mong ;dul~ without a college degree than 

among college-edocaied aduiK Research wgg.,lslhal 

A. Primt·3gc 13-bor fM"e p311icip31ion r.ncs 

Sott Thrl!bbare~ ~Tht~Ntsildio.w~ 

of~ r~'twDti dtfD:,! b)• tx ~ Bwmcrl~ 

'"""" So.:ta BI.I't3ad~~ 

increases in au!ornation. such as the use oi robotics. 

and \'3fious aspec~ oi globali,.tion hm spurred 

1he eliminalion of <Orne lypes of jobs-in particular, 

some manufocturing jobs !hal h"'~ histor~llr been 

held by \\OOte~ wilhoula college education-and 

eme<gingjobs mar require a diiferenl Itt of skills. These 

developmeniS mar ""'•led "'""' """'"' 10 become discour;god "'"" 1he lack of S\Ji1<1ble job OflPO!Iunities 

and dropOUiollhe labor force.' The ~ng share of 

college-<ducated ""'ke<s, whidl m.l)' partly reflecl 

indi,;duals r"'Jlonding 0\'0IIime to lhe declining 

demand for jobs lhai require less education, has likely 

pr.--ented 0\-en ~eeper r~lines in lhe prime-age LFPR. 

as bette< -educated worke<s h<l\e highe<LFPRs and 

may be more adaptable to unfO<..een disruptions in 

particular lobs or iodoSiries. 

Anolhef po1en1ial factor may be !hat an incr~ng 

share of lhe prime-age population has some rfiff~ulty 

\\Ming bec>vse of f)h)•ical or n1en1al diSJbililies. 

For el<.lmple, flgUfe C shcn•• !hal about 5 pe<cenl ci 

bOih f)liroo-age men and women reportlhallhey are 

ou1 oi 1he labor force and do nol """'' job due10 diSJbilily or illness; !hose shares h.l'e ~ended highet 

"'"' 1he past "'""'I decades. Olhef research wgges1> 1h.a1 iocreased opioid use may be ;,mociated with 41 

10\,er prime-age LFPR, although il is unclear hOiv 

much of lhe decline in lhe prime-agelFPR can be 

dire<!~· explained br Of>ioid ust or "ilether increases 

(conlinuedl 

I. for Miera oo d;,plac"""" '""" tt<hnologK-.JI ct.....,_ S<e0>.id H."""'- 03\id Oorn, •nd Go<don H. Ha.,..llOtSI, -u,.n&lingTr>de.OOT<Ciu>ology:E,·idenc• irom Lcolt..abot M1ri:et5," (COI'ICWr)(' loorrul, \'OI. 12) ~\\.1)1. 

W· Gll-16; o,..., Acemoglu ond r.scu.1 RC'511epofl017~ 

•lloiJols and fol>so Evidence from U.S. Llbor Mo&tts; 'BER 

\\'odin& P..-per Stvies l328S C.Jinl:wid~e, ~\m.: National 

lkue.au Oi E<ooomk Rese.arch. Ma«hl, 1\'wv..nber..c)f,&' 

plj)MI\vl32BS; and O"""Acemoglu and Pa<cual Reslrepo 

(10181, "AMK~Il~e1Hgence,A!Jtom41ior1. and\\'~' '11ER 

II'O&ingP4ptrSO<i<$l4196 ~.•'""- -'~;on,l 

8v"<u of f<ooom~ Res<•rch. ~Mryl. llllw,nbef.or&' 

p.J:per.Jwl-1196. Few E.'\<idence on glol»liution-in p.lrtictJI~ 

impott~itionsillCttht 2000$~0a-.id A~Of, 

Oa"id Oorn, and Go<don H. H..,.. (lOll~ "Tht O.illa 

Synd.-: Loc.!llabor Ma&~ rif«<S of lmpon Com"'""'" in the Uniled Sl.a:es: Amttk.dn Ccooomi<: ~·iew. \d. 103 (OctoiJ«), pp.llll-68. A d"""'ioo oft'-"< and othe< 

e>p~.,..,;..,. ~also P<"''ided iA Kam.nne G. Abr•ham and Meli<~a S. Ke.l""!'ilOIBI, "b:p~irung 1he O.:l;nein 1he U.S. E~<o-lllput.tiooRalio:A Rev<wollhe Evidence; NBfR WO<I<iog Papers..;., l4133 1C.mbrici;<, Mass.: 

N.llional8urt.lu oiEcooomic ReseMCh,. frorwrv). \\\\W.nbet. 

"'&P•P'"IwWll. 
157 


71718012.eps

MONeTARY POLICY Rtl'ORT: lUll' 2013 9 

B. Prime·a.gt labor ron.."'e pallicipation rates by fducation 

Worrw:n 

-1'8 

_, 

- !0 

- 86 

Non:: The data are scasooally adjast«<ll-mooth mo,tng atms-.-s and <~te-nd through May lOlS. TM :sbadcd bus indk:atcp:-riod$ of busi~ ~t~."'I."SSi\Jn as defined b) the Natioll31 Buccau ot Ecooomic ~:arcb. 

Socao.:: U.S. C~s Bttl'\"3ll Cbrm:u Popt~btion Stm't)'· 

in opioid u<e are an indirecl re<ull ol poor eMploymenl 

opportunities.

1 

Caregi,ing r"'iJJ'''ibjlities play an import.ml role in 

expi.Jining "lly LFPRs for prime-.Jge women are lower 

than for men, and the)· n\a)' play an increasing role in 

e>:pl.lining de<lining prime-.JgelFPRs for men as well. 

As shown in figure C, rooghly IS percent ol primeage women report be;ng out ollhe labor force for 

caregi•ing reasons-by far the largest , .. son for primeage "omen to report not wanting a job-but this share 

has been fairly 141 "'~ aime.ln cor*•ll. while a much 

smaller fraction ol men ;ue out olthe labor force fO< 

u regi\•ing reasons. t.hat s!Mre tw:s trended up in recent 

decades, likely reilecling some sh;ft in household 

2. £\idence lhilt opX>id use could be signifiiC.lnt for 

undffilanding the doclillioglfPR ;, pr<w<Jed 17! Alan B. 

K'"'&"'\ZOin, "111lttelia\tAIIoheWO<k"'CootiAn 

l"'!!lity into !he Decl<oe rl the U.S.l>lw f01<0 P.ulicipJtion 

R>:e; 8Joof;;ngs P•pe<l Ofl !c"""""' AriMty, F•l~ pp, 1-32, 

hlrps "'"".b<ookings lX""'"'~l&llll 

klueg«taof•llbpeJ.pdi, \\-hi~ little re-.iorohip """'"" 

op'<>i<! pr<s<rip6ons ""' .....,..,...,. a1 the """"Y l<>tlo fouDd in I.Jnet Currit>, lorus Y, lin. i!nd Molly Schrwll QOI31, 

·u.s. Emplo,..,.,. •nd Opioid>: Is There • Cormea<>nr NBER II'O<kinsP.>per SEries W.W !Umb<idgt, ·'""-' N.lt.iooa18urNu d Ecooomk Rese.Jtclt acch~ \\\\\\,nber, 

orsfP3P"""l"40. Some "'i<lenceOfl•hdhe< illeq>io<l epidemic v.tri(>s with loc-.a.l «onomic ooncfitions is pt01>-ided 

by feff lanimore, Alex Duran.:t. Kimberlr Kreiss, Ellen 1\.t,etry, 

responsibilities as women participate in the woMorce 

in greater numbe<s. for ~ially those for 

whom childc.are costs are not a major concern-no~ 

p.utkipating in !he labor force may rep,....! an 

unconst,.ined choice to care for olher membffl oi thei< 

families. for others, howe>~. 1his decisioo may reilec1 

alack of affordable chi Idea,.. 

Addilionally,lhe share ollhe populationpanic lar~· block men-will> a hilloryol incar«<ation 

"" increal<!d "'~ time. lndoiduals who""'"' 

pr .. iously been incare<t<!ed oiten ""'"' uouble finding 

""'t in pan because many emplo)-et~ choose 001 to 

hire people with su<h a bad<ground and likely also 

in pan because in<•rceration preven~ IJeOPie from 

accumulating"""' experience and de\oeloping skills 

'·aluable to emplo)"'"· Discrimination could also help 

explain !he lack ol panicipation for some minority 

group>. as •hey ""ognile that such discrimination 

limiu !heir job opportunities. 

ln<ernaliorul comparison; may help clarify the 

importance oi some ol those f.1ctoo. Since 1990, !he 

(contirwed on nexl page! 

Chri•ina P•rk.•nd C~ud~ Salrm\20131, S~mr"lgl;g!\1"" 

Our Ecooomic .Jnd Fin.1ncial Lio.·es; FEOS NOles, h~A'<v.\\, 

iederdfresen.'! got."J'«OM'!Inol:~nolesfshedding-light.on· 

our-ec«XXIfllic..and·flnancial·I~'\'S 2018051l.hlm. 
158 


71718013.eps

The Labor Force Par ic ipation Rate rcominwdJ 

C. Prirrte·3gt nonp3rticipa1ion b)' reason 

- 16 

- " - 12 

- 10 

- ; 

Non: The d3la art ~sonaiJy adjLISIN ll·moolb mo,inga·l'trng.::s aod ntmllhrough Ma)' lOIS. 11M~"<< bars indk21t> 

~"tiood$ of~)if~C'SS rcn~n 3S dctira<.:d b)· I he ~31ioool &rt:~u of Economk R~~':lrth. 

Soulre U.S. Cmsus llr~\J. Currtnl Popu.la1torl SLI.I'\'C)'. 

ptime-agc LFPR in the Unit..O State> has de<lined 

conside<ably for bolh men and \\(K1len rela~il-e 10 other 

ad»n«<J counlries. Some factors, like automalion and 

glob.llization, ila>'< affected all atl.•nct<J economies ro 

some degree and foe some lime, )'<i dil'<rging long·ron 

rrend< in prime-ago lalxi< foo:e participation ha'e ll 

occurred. Re>earch ~thai part oi the reJati,-e 

de<line in the United Stat .. ~ e;p!ained by diffe<ential 

changes in work-famil)' pofic:ies across countries. 

Olher parts of the dil'<'gence rna)' be ""plained by 

other policies, indudingp<>licies designed t"''"d 

keeping those affected by automation and glob.lliution 

a ruched to the labo< force, or other fa<toe>-such as 

incarcefation or opioid use-4at differ ac<oss those 

countries..1 

Although many of the factors behind the 

multide<ade de<line in the ptime·•E< LFPR may 

persist. 50me continu.uion of the incre.l$t$ in the LFPR 

0\-er the pa~ few years II<''OIIhei<ss seems possible, 

especially if !abo< marlet conditions remain fol\1lf.lhle. 

Indeed, as shO\·m in figu<e C. although the share of 

nonpal1icipating ptime-age men and",.,.,.. \\M 

J. for receot trends oo prime-<v"lFPRs in the United 

~at('S (()f't~rtd with ~her de---eloped coun!rie'S, see 

~"'ion.,. EcooomicCo-optr"ion and De\~ 

U013), OfCO Ccr>norr>ic Sun")>: Unir<r!~"" 1018(Paris: OfCO Pu~ishiogi cb.~O.Ii371«o..w•-q>-usa·l013-

oo. For <1 dtscription d polityd"afffftOCes ac-ross cou~rifs 

self·rep<>rt as """ting a job (de;pite not hol\;ng actil-e~· 

searched for a job recently) has been declining since 

20t 0, !hot sh.lre foe men remains between II and 

11 pe<cenragc point ab...-e i~ 2007 I<-eland eatlier 

""pansion pealcs. furthermo<e. ptime-age men and 

",.,.,.. "llo had prO\·iously rep<>rted being oot oi the 

labor force and not "•nting a job due to disability or 

illness ha"e been enre~ing the lalxi< force at increasing 

rales in recent rears. 

looking fomord, hO\'' can politymaketS suppo<t 

additionJI imptO\-emen:s in 1he prime·agc LFPR? 

fol\'OOblel•lxi< market condirions can likely help. 

and monelary policy can rhe<ciore play a role through 

suppo<ting Slrong cyclical conditions as part oi ill 

maximum-employment objecli\'e. Howm-er, Sltudural 

factors lin contra~ wirh cyclical Ofi<S} "e also 

important to addr(>SS; policies to address ~uch factoo 

are be)<>nd the scope oi monel a~· policy. 

and how 1M may aff«t diiier<nc« in tfPR. seel~""'tion>l 

Moot<")' fund aOJ31, 'labor fcrceP,n<;palioo inM·anced !conom;,s: o.;.,, and PrOSj)C<~; c•2 in ll'"ld 

!c-Ou!look:C)dico!IUpl"~SUocMo!ICh.lnge 

~Ya>hinston: tMf; Aprill, Ill' 71-128. for "'"""'•on how 

"¢.familypolki<lmayaiicapri~lfP!tsinll>tUoi:ed 

5u:es relati\-e to dher Q(CO coorntil's,. see francine 0. B!au 

and J.a\\·rence 'l Kahrl 1201)). ·r.m..~t tAbor Supply: 111>y 

lslheUnired Stn<'S F.allit~g Btbindr A.tnttk.m~ 

-'·'"'·10li'la)' pp.2Sl-Si>. 
159 


71718014.eps

more rapid~· during expansion~ lndffil. 

the declines in the unemplo)ment rates for 

blacks and Hispanic;; ha1·e been particularly 

striking. and the rates have recently been at 

or near their lowest readings since these series 

began in the early 1970s. Although diiTerenccs 

in unemplo)ment rates across ethnic and 

racial groups have narro"ed in I\'ICtllt )ea~ 

they remain substantial and similar to pre· 

rt'ctSSion kl-els. 'fb( rise in LFPRs for prime· 

age indi1 iduals over the past few )ean has 

also been e1 ident in each of th~ racial and 

ethnic groups, with inmases again particular!)• 

notable for African American~ Even so, the 

LFPR lor whites remains higher than that for 

the other groups (figureS).' 

lncrtases in labor compensalion ha1e 

been moderale ... 

Despite the strong labor market. the a1ailable 

indicaton generally suggest that increases 

in hourly labor compensation have be.:n 

modernte. Compensati.on per hour in the 

business sector- a broad-baS<.--d measure 

of 113ges. salaries. and benefits that is quite 

1olatile-rose 2% percent 01-er the four 

quanen ending in 2018:QI. slight!) more than 

the 01\mge annual increase 0\er the pn'tcding 

se-en or so )"tats (figure 6). The empiO)ment 

cost index- a less I'Oiatile measure of both 

wages and the cost to employcn of pro1 iding 

benefits like"isc was 2% percent higher in 

the first quarter of 2018 relative to its year· 

earlier le1·el: this increase was 'h percentage 

point faster than its gain a )CarCJrlier. Among 

meawres that do not account for benefits. 

01\tragt hou~· earnings rose 2'< peroolt in 

June relati1e to 12 months earlier. a gain in 

line 11ith the a1·erage increase in the p~'COOing 

few years. According to the Federal Reserve 

Bank of Atlanta. the median 12-month 11agc 

4. The t"''" 1<\<1< of labor fore< panicipauoo for 

tlw>< olhtt pwpsdilfer illlponant~· by"'· For Africaa 

,...,.. ... - lu>• . ... ,p>rlicipnioo "'" """" to • lo:t 111m. •llilt Ill< partiripolioa nolt IOf African 

iiiDtnC>ll•"""" ~"' •i!ltaslhat or •ll•t< ._,_ B) 

contt.l5t.tli< loa<r lFPRs fllf HispaniCS ond AsioJb 

rcflc:tt 10\\n pJnicip;uioa among ~a.omt'ft, 

MOMTARY POliCY REPORT: MY2018 11 

5. ,..,... ...... rom: ~ ... -byractaod 

<tl!ructty 

- -

-ij " 

-~ 

_., 

10 

_,. _,.. - n 

,. 

\ort:lhc-l'l'f'INCt.._~~ra.:is ~oltbt 

,.~~u-~ hnom•t~DK~~~·~· 

i.Jmo)BI)kfl-r~ Tk-lft~+Wt,·h'tltutr 

.Di llt ~a)llllf*'<ftFt. rktbloWhr~ apmlll tl 

~~ ... -.-,.'*-ia.e.tl~lbar<\. 

s.:...r-a.ca.tfl.IM~' 

-· 

_, 

-· 

LL......... MIO 1011 

~ 

1-' 1016 Ml~ 

\ml:~-~1:'1)11 1~~~ 

-. «lk~_..tolle.k\.~~""(f *• ~~11" 

llltltla--ela..ilqr.Mtr;f« ~a..t)~ct.wrtSU..I! 

~adltl;flrlkA*-rot, v. .C.0.1111TD<.i.a'.o.t-._. 

...... ~--... 1\~···!...-po:rg.w; .. ., ..... _...,,.,, Six*'.: lwa.fl ... ~, .. tt.r.;:r!bll)~fiCd.:r11~ 

kletAIIIIca,••c-.•ttdcr 
160 


71718015.eps

l. Cilang<in bulintss-s«tor OUtP'Jt per boor 

_ , 

-; 

-l 

SQn ~if'ti!IC'-cdflU!IIC)aolihr)~~-Jy~ 

tb:~~Q:(I(Ikli!W "C' .. oltkpericd. Tht- fll'ldp.oftod is m:-&.U{dfrom1COO!Q-:~2018!QI. 

Sot.IWi! Batlllafi.M....,SLI:Nics "iafLI.\'tt~ticf.. 

growth of individuals reponing to the Curren1 

Population Surrey increased aboU13\\ percen1 

in May, also similar to its readings from the 

paS1 few years. s 

.. . and likely have been restrained by slow growth of labor productivity 

Those moderate rates of compensation 

gains likely reflect the off selling inHuences 

of a strong labor market and persistenlly 

weak productivity growth. Since 2008. 1abor 

producti,;ty has increased only a linlc more 

than I percem per year. on average. well below 

the average pace from 1996through 2007 of 

2.8 percent and also below the average gain in 

the 1974-95 period of 1.6 percelll (figure 7). 

The weakness in productivity growth may 

be panly anribtnable to the sharp pullback 

in capital im·estmenl during the most recen1 

rece;·sion and the relatively slow recovery 

that follo11~d. Howe1-er, considerable debate 

remains abomthe reasons tor the recem 

slowdown in productivity growth and whether 

it will persist• 

Price inflation has picked up from the 

low readings in 2017 

In 2017. inflation remained below the FOMC's 

longer-run objectil•e of 2 percent. Partly 

because the softness in some price categories 

appeared idiosyncratic, Federal Reserve 

policymakers expected inflation to mo1-e 

higher in 2018.' This expectation appears to be 

5. The Alb11ta Fl."dS mt'3sure difttr.s from Others in 

1ha1 it easures ~ wage grov.-1b n~· of work«S who 

\\"tn! e:mptoycd both in 1he C'urrtnt Sufltymoruh aAd 

12momhsearlier. 

6. The bo' "ProdUCii,·ity De\'clopm<nts in the 

i\d-.n«d Eoonornies in elu 1Q l.I/IJIU!IQf)' 

Polity Rtp!m pto,id.s more information. S.. Boefl! 

of Gowmors of the l'e<krnl Resen·e S)>tem (Wil). 

MMftOT)' Polity Rtpon (Washington: Boord or 

GO\·<rnors. July). pp tl-1 J. hnps:ll""'".fooemtre•"'·e. 

gov/mone<arypolk)·/1Qll·Ol·mpr·p.tnl.htm. 

1. ;\dditional details. ran be found in the JurlC 2017 

Summary of Economic Projectioos. an addendum to the 

nut,~of oe June2011 FOMC mNting. S.. Boefl! 

of GO\tmors of the FC<fernl Resen< S)>lem (2011). ~~li u1es of the Federal Open Market Cornmittce. 
161 


71718016.eps

on I rack so far. Coosumer prict infta1ion. as 

measurtd bylhe 12-monlh pem:nlagechange 

in I he price index for personal consumplion 

cxpendiiUres (PCE), mored up 10 2.3 pcn;enl 

in May (figure 8). Core PCE inflmion. which 

excludes consumer food and energy prices !hat 

are oflen qui1e rolalile and l)pically pro> ides 

a beuer indicalion 1han I he 1o1al measure of 

where 01erall inflation "ill be in 1be fulure. 

was 2 pcrctnl 01er 1he 12 monlhsending in 

Ma) 0.5 perrenlage poim higher !han it 

had been one year earlier. The 1o1al measure 

exceeded core infla1ion. b.--cause of a siable 

increase in consumer energy price~ In 

contrasl, food price infla1ion has corninued 10 

be low by his1orical s1andards-da1a lhrough 

M3)' show the PCE prioe index for food and 

be\eragcs ha~ing increased II'>Sthan 'l: pcrctOI 

0\Crlhe past year. 

The higher readings in bolh lotal and core 

infla1ion relalive to a year earlier reflttl fasler 

price increases for a wide range of goods and 

serrices I his )'ear and the dropping oul of 1he 

I 2-monlh calculalion of I he Sleep one-monlh 

decline in I he price index for wireii'>Sielephone 

stl\ices in March last year. The 12-monlh 

change in the I rimmed mean PCE price 

index-an allemaliH: indica1or of undtr~ing 

inflalion produced by the Federal Restl\( 

Bank of Dallas that may be II'>Ssensilile 

I han I he core index 10 idiosyncm1ic price 

movcmenls- slowed by less I han core infta1ion 

over 2017 and has also increased a bil less 

1his year. This index rose 1.8 perctnl om I he 

12 momhs ending in May. up a IOlKh from I he 

increase 0\-.r the same period last )tar.' 

lull< 13 14.2011," pmo ~icaS<. Jui)' l. https:// 

'.1.\\'\\ .rooc-rnlrcst!' '·SO\"Inro-st\nt"pr&~lca'iN 

monttal)101 iOiOSa.htm. 

8. Th< trimmod mean in<kx<'«lud<> •hart~cr Jlf1'<S 

""*nl rio< b'l'<'l iom355 or ck<m"' oaa """ ..,.Ill: b-cwnplt. rheslwpdniiat 11 pric<sb-

•11<1<» t&phooc !mi«s,. ~ta~illOI J •» <l<'fudN 

fromthi,~ 

MOMTARY POliCY REPORT: MY2018 13 

- 10 

- ! t 

• lj 

It 

w - J 

---

L.t............ - I 1011 2012 201) ZOI~ 201S 11)l6 2017 201S 

\\m:TbrcOW..f\lt.'OoStllous' lly.))lf:~.-tfnwnont)IW 

..... Soc.wr. f«lllllftlt.-.faSnlltorc!\tWfllDalbrl;:b• ct;t. 

Blftalel&...:A..t)'t>..•'•"-crAIII}1trr."5. 
162 


71718017.eps

9. Brrno spoo ond filrut<S priees 

- IJO 

- 120 

- 110 

- oco 

!0 

- co 

lO 

co - ,. 

Son! Th: 4r..llll\' 'i!IC..i.tj. ~of dally dl:a IOJC'\l«ld ~ 

Mr11.1<llt 

Soun.: CEBfttllftr-J:a:,u~ 

no - - 101 

- 100 

- 9S 

co -

~ll ~Jl Nl4 Wl5 2:016 :017 lOIS 

SO'n; llxQ:... CxrR.'adia:lpx1~-~:tQXIibl) DiC'\k'DJ~ 

Mt.~ lli$.Tk~ or~I!Xtlba: •~f\~of43if) dl:a 

Dl<>IO>l""'-'b""'l9.l01S. Soli((: F« C«<fo.i ~ ~ ~ o( b.\Y ~ t'« 

~ (IXUlt.. s .. u SC'I ~ ~~~%«~\Ill litl\"1 

AM~ tiel.. 

Oil prices have surged amid supply concerns ... 

As noted, the faster pace of total inflation 

this year relatio·e to core inflation reflects a 

substalllial rise in consumer energy prices. 

Retail gasoline prices this year were drio~n 

higher by a rise in oil prices. The spot price of 

Brent crude oil rose from about 565 per barrel 

in December to around S75 per barrel in early 

July (figure 9). All hough that increase took 

place against a backdrop of cominued strength 

in global demand, supply concerns have 

become more prevalen1 in reccn1 monlh& (For 

a discussion of the reasons behind the oil price 

increases along with a reo~ew of the eft'ects of 

oil prices on U.S. economic growth. see the 

box "The Recent Rise in Oil Prices" ) 

... while prices of imports other than 

energy have also increased 

Nonfuel import prices rose sharply in early 

2018, partly reflecting the pass-through 

of earlier increases in commodity prices 

(fignre 10). In particular. metals prices posted 

sizable gains late last year due to strong 

global demand but hare ret rea ted somc1111at 

in n.'Cent week& 

Survey-based measures of inflation 

expectations have been stable . . . 

Expectations of inflation likely influence actual 

inflation by a fleeting wage-and price-sening 

decision& Surwy-based measures of in Hat ion 

expectations at medium· and longer-term 

horizons hao·e remained generally stable so 

far this year. In the Sumy of Professional 

Fon.usters conducted by the Federal Reserve 

Bank of Philadelphia. the median expectation 

for the annual rate of increase in the PCE 

price index orer the next I 0 years has been 

around 2 percent for the past several years 

(figure II). In the Unirersity of Michigan 

Surveys of Consumers, the median value 

for inflation expectations over the next 5to 

I 0 years has been about 2\', percent since 

the end of 2016.though this Jerel is about 

V. percentage point lower than had pre>-ailed 

through 2014. In contrast. in the Survey of 

Consumer Expectations conducted by the 
163 


71718018.eps

Federal Resm-e Bank of 1'1~ York. I he 

median of respondenrs· expected in Hal ion ra1e 

1hree years hence has been moving up rectnlly 

and is currendy a11he lop of the range it has 

occupied Ol'er the past couple of years. 

.•• 1\hile market-based measures of 

innation compensation ha1·e largely 

mo1 ed side\\'il) s this year 

lnHatioo c.'pcctations can also be gauged 

b) market-based measures of inflation 

eompcnsation. Howel'er.the inference 

is not straightforward. because market· 

based measures can be importanlly aft'ccted 

by changes in premiums thai pro1 ide 

eompcnsation for bearing inflation and 

liquidit)' risks. Mrasures of longer-term 

infta1ion eompcnsation-deri1ed cilher from 

differmces btt"l!ell yields on nominal Treasul') 

securilies and those on eomparable-maturit) 

Treasury lnflation-Prolected Securi1ies 

(TIPS} or from inflalion 111~ps ha1·e mol'ed 

sideways for I he mosl part I his year atler 

having reiUrned 10 lel'els S<.'en in earl)' 2017 

(figure 12}.'The TIPS-based measure of 

5-lo-IO.)r.tr·forward inflation eompensalion 

and I he analogoll$ mea;ure of inftalion swaps 

are now about 2 pereenl and 21': pclt'tlll. 

respcctndy. "ilh bolh measures below 1he 

ranges I hal pcr..istcd for mos1 of the 10 years 

before I he s1ar1 of the nolablc declines in 

mid-2014.

10 

9. lnlbtion compensation impli<d by 111< TIPS 

~"' icll.ttioo ratt ~ boS<d on th<dolfmocut 

C\lllj>Or>bi<mluriti<>.bec• ... )idd>OO"""" ... 

Trmol} «a~~~~i<sw)ldd,; oo TIPS. •hoc!lorr111&l<d 

totll<k!IMaJilSWII<fpric<~(CPIJ. lafbtooa""PS 

1rr romoosin •hich oot pon) mili> Jl3lll1tll~ or ~rtaln fiM.'d nomin31 amou11ts in twhn~ ri.lt cash 

ftffi'lthat "~ index.C'd 10 cumuiJii\< CPI inH:uion OH'r 

some horizM. Ocu)ing on inflattoncornpcMalion 5to 

10 )<aru.h<ad is useful paoti<ul3rly for mo""Ull) policy. 

b«3u« such fol\l~«< mtasu"" <nrompas:. mark<t 

~niripanu',ft-s about wflere inllation 'lAili )(ttlt in tbc 

loasttrm •fkrdc\tto...,..ts inftutncinsinlbtlOII in th< 

sbon term hi>< ruo t11rir roDJ>t. 

10. Asth<oe.....,.,..aoel>os<dooCPIIIILuoo. 

00< >llollld prob>bl) subtnct ahoot '. to •,; 1""""1>¥< 

point th< ;nm~ d[~=tial•ith PCE infbtioo '"'' 

the pa~ h\O <kcldts:- 10 in ftr inftation comp:n~twn on 

a PCEbo<i> 

MOMTARY POliCY REPORT: MY2018 15 

-

- I 

~~ · Tb: M~~:bi .. III'IC)' 6at1 rtt mor4ty, Tb: Stf 4m for intl.at1011 

op.~f«pmcoal~npaldrtl#C'f~~·Wco'W'Dd 

m~'O•......,lOtiQl 

Solwt: ltn~ti\IIL'fllp~~'SolC~Ftd:n!IN1\co 

Bdttl~$w\c,.i~fctttMIItf\t$f'f\. 

,. 

- u 

,. 

-IJ 

-,. L......u......u ,z .. ,,,.," r. .:'010 !01! :014 2016 ~1$ 

~. Thrd»wt M\"4.~ J'l~ol~ 4aci..J~Uted llwOIIJh hl)~:xttS.nPSr;:t~•dlat~"W~ 

SOI.m· rcdml RM-ot w of ~ \'91\. ~). ro.1collttitf'lt 

""""'"-
164 


71718019.eps

The Recent Rise in Oil Prices 

Oil p<ic., h>l~ increased more than 50 pe«:ent 

0\'l!f the pa~ l""· with the spot p<ice of Brent crude 

Oil rising from a bit 0010\V $50 per barrel tO ai'OUOO 

SiS per barrtl (tlgure AJ. for much of the period, 

iunhet-dated futures prkes remain<O reloti1~ly sl<!ble, 

in the neighbofhood of SSS per barrel; h''"~""· since 

February, futur., p<ic., """ fll0\.0 up app<eciably, 

reaching 0\'ef $70 per barrel. 

Bolh >upply and demand factO<> M'e CO<ltriboted 

ro the oil price iocrease. In p3nicular, the broad-based 

imprOI'efnent in the ovuook iO< the global economy 

was a ~(!)' dri\"er oi the price increase in the second 

half of 2017.1n recent months, supply concerns ha1~ 

become more p<evalent affecting both spot and furtherdated futures prices. Despite sharp!)• rising U.S. oil 

p<oduction, marke~ ha~'e bten attune< to escalating 

connict i>e!l1'ten Saudi Arabia and Iran as well as the 

p<ecipitov><!ecline in Venuuelan oil p<oduction amid 

the count~/' economic and poiti<al cris~. Prices ako 

increased aner President Trump announced on Ma)' 8 

that the United Slates was withdr;n.,.ing from the lrJn 

nuclear deal and that "nctions again~ Iranian oil 

exports would be eins~ted. 

The pattem of spot and futures p<ices iiiOicates 

that 1113rket pilnicipilnl> generally anticipate that oil 

pri<es 11ill decline slowly over the next few )'earS, in 

pan retlecting'" expect. lion that supply, including 

U.S. !-hale oil production, will gt0\1' to l1lE<I demaoo. 

In addition, the higher p<i<es pu1 p<es>ure on OPEC's 

NO\'ember 201 b agreement with cert.Jin non-OPEC 

countrieos 10 restrain production. A Slated aim oi the 

agreen1ent 11~s to reduce the glut in global n~..,tO<ies, 

and, in recenl months. inv~nlocy le\-efs ha\-e iallen 

ldpidly toward long-run awtages. In response to both 

l01ver im'entories and higher prices, OPEC leaderS 

~ightl)• relaxed the production agreen1ent in June thi> 

(corr!inu«<J 

- 90 

_,. 

_, 

- «> 
165 


71718020.eps

)~ar, reducing some oi 1he upward pressure on priCI'I. 

Thai !did, fulures prices h.r.~ 1101 re\Uin<d 10 !heir early 

20181evels, imp~ ing 1ha1 mad:el panicipan~ expecl 

some oi 1he recto I incr<>ase in prices to be long lasting. 

IVhal is 1heexpec~ed effec1 of 1he recefll rhein oil 

p<ices on 1he U.S. economy? To begin wilh, high« oil 

prices are li~ely 10 resYain household consum1~ion. 

In p.1rticular1 the incttase in oil prices since last year 

~ es1ima1ed 10 h.J1~ 1ronsla1ed inlo a roughly S300 

ii"'Crease in annual expendituces on g.noline fOI' the 

3\'1'138' household, from ahoul S1.100 10 S2,400. 

H"'"''"'· as U.S. oil produclion h" IV"''" rapidly 

"'"'lhe pa11 decade, 1he ra1iool ne1 U.S. oil impons 

lo U.S. gross domeslic p<oduc:t (GOP! has declined 

suhllanlially (figure 81. As a result higher oil prices 

n01v imply much less ol a redis1ribu1ion of pu<Ch.Jsing 

8. Nctoilimponsharc 

I I I I, I I, I I I I I I, I 

:»li!OOl~lfi/I2009NI12'01lZOUlOI?~l9 

MONEIARYI'OUCYREI'ORT: JULYI018 17 

pow« abmad lhan in 1he past as much of !he nega1ive 

effect on GOP from l011-et household conwmprion 

is likely 10 be offsel by inaeased produclion and 

in~'eSl.melll in lhe IVO'\''ing U.S. oil se®r. On netlhe 

drag on GOP from higher oil p<ices is likely a small 

iraclion oi ~~~al il was a decade ago and should get 

smallet slill il U.S. oil produc:tion conlinues to gr01v 

"jli'Ojecl<'d-<.gure C-and 1he ne1 oil import <hare 

shrinks toward zero. 

Indeed, if U.S. oil uade 1110\.., fully into balance, 

lheoiisetting effeciSof a change in the relatil~ priceoi 

oil mighl be expected 10 ne1 oul within the domesti< 

e<:ononl)'· How'e'\oer, f\'tn if the United States is no 

longer a net oil importer, to 1he extenlthat highe< 

oil pt:ices cause credii<OlUirained consumers to cut 

spending by morelhan oil producers exp.1nd !heir 

in,~nl. this edi~i~tion oi purchasing po-orer 

could !lill have negalil'e effeciS on 01-erall GOP. 

C. U.S. crud< oil prorlli<tioo 

_,, 

- 12 

11 

- 10 

- ' - 8 

I''"'"'''"'"""'''" ' I )ll~ 20lS ZOI6 :'011 2'01$ Zlllt 
166 


71718021.eps

13. O..nse ;, r<al gross dom..'SO~ produco and gross 

domes!i<: income 

..... _, .. 

_ , 

Ql _, 

- ) 

- 2 

_, 

14, Ch:tnse in n:al ptrsooal ronsump1ioo c~nd tures: 

and disposable p.'1><lfl3! iocome 

_, 

_, 

_ , 

- ) 

_ , 

_, 

_, _, 

_ , 

~Oll~ Tht\1;1ucsbb)I3:HI~Iflt~~ I)Q4~"S. 

SOU<f: Bl.mae(E~A~~~11 b\uAflal:. id 

IS. Pcrsorolsa\ing t3te 

- -11 

-10 

- 8 

J I l I I 1 I I 1 I I I I I 1 

!1).16 '2«18 0 l012 Xl14 2016 l'OJS: 

San: D~lu.r~lk• '~r20tS 

Solt<t: S&muo!Eooa.:.mk~'Si:;: iatb "CJArW)ticr.. 

Real gross domestic product growth slowed in the first quarter, but spending 

by households appears to have picked up 

in recent months 

After having expanded at an annual rate of 

3 percent in the second half of 2017, real gross 

domeslic product (GOP) is now reponed to 

ha1-e increased 2 percent in the firs1 quarter of 

this year (figure 13). The step-down in growth 

during the first quarter was largely a11ributable 

to a sharp slowing in the gro111h of consumer 

spending that appears transitory. and gains in 

GOP appear to hare rebounded in I he second 

quarter. Meanwhile. business investment has 

remained strong. and net exports had lillie 

etfect on output gro111h in the first quarter. On 

balance, over the firs1 half of I his year, 01·erall 

economic activity appears 10 have expanded at 

a solid pace. 

The economic expansion continues to be 

supported by fa1·orable consumer and business 

senliment. past increases in household 

wealth, solid economic gro111h abroad, and 

accommodative domestic financial conditions. 

including moderate borro111ng costs and easy 

access 10 credit for many households and 

businesses 

Gains in income and wealth continue to 

support consumer spending . . . 

Following exceptionally strong growlh in 1he 

founh quarter of 2017. consumer spending 

in the first quarter of I his )'ear was lepid, 

rising a1 an annual ra1e of 0.9 percent The 

slowdown in gro111h was evident in ouilays 

for mo10r 1•ehicles and in retail sale$ more 

generally: moreover. unseasonably warm 

weather depressed spending on energy services. 

Howe1·er. consumer spending picked up in 

more recent months as retail sales firmed. and 

PCE in April and May rose at an annual rate 

of 2\'. percent relative to I he average orer 1he 

first quaner (figure 14). 

Real disposable personal income (OP!), a 

measure of after-lax income adjusled for 

inflation. has increased at a solid annual rate 

of about 3 percent so far this )'ear. Real OPt 
167 


71718022.eps

has bctn supported b) the reduction in income 

ta'es 01\ing to the implementation of the 

Ta, Cuts and Jobs Act (TCJA) as 11ell as the 

continued strength in the labor market. With 

consumer spending rising just a little less than 

the gains in disposable income so far this year. 

the personal S3\1ng rat~ has edged up after 

having fallen for the past t\10 yms (figure IS). 

Ongoing gains in household net 110rtb hktly 

h:l\e ai>O supported consumer spending. 

flouse pri= which are of parti(ular 

importance for the balance sheet positions of 

a large set of households, ha1•e been increasing 

at an a1·erage annual pace of abo11t6 pcrtent in 

recent )~ars(figure 16}.11 Although U.S.t'quity 

prices hart posted modest gains, on net. so far 

this )ear. this Hattening followed Stltral years 

of sizable gains Buoyed b) the cumulati1-e 

incrmes in home and ~uity ~~ate 

household net worth was 6.8times household 

income in the first quarter. down just slightly 

from its ratio in the fourth quarter the 

hight~t-ever reading for that ratio. which dates 

back to 19~7 (figure 17). 

... and borrowing conditions for 

conwmers remain generally fil1orable ... 

Financing conditions for consumers are 

gell(rall) fa1orable and remain supporti1e 

of gro11th in household spending. o11e1~r. 

banks hare continued 10 tighten standards 

for credit cards and auto loans for borrowers 

11ith low credit scores. possibly in n.-sponse 

to some upward mores in the delinquency 

rates of those borrowers. Mongage credit bas 

remained readily :1\-ailable for households 11itb 

solid credit pro~les. For boiTOII~~ 11ith !011 

credit scores. mortga.,oe financing conditions 

ha1e eas..'d somewhat further but remain tight 

overall. In this en1 ironment, consumer credit 

continued to increase in the first few months 

of 2018. though the rate of increase modemed 

some from its robust pace in the pm·ious year 

(figure 18). 

II. Forlh<1113jorit)of~,h<>mt<qull) 

m:ol<> up th< lat;'<>l sl!are of tbtir •<3Ith. 

MOMTARY l'OI.ICY REPORT: MY2018 19 

- '"(r<'"; 'I« - u •h !n - to 

- s 

- 0 

- l 

_,. 

- u 

~ 

~11: lb:d.luror~S.~Pf~lkrllldtlu:cod~ApnllOtS. 

11< ... f«lklol""aboodib<C~®M1<11d~ lll) !Oil 

Scun: f«~ llo.._ PncT ~Uno.~ SlPC~ l.S 

~lb!atfn«l!ldn. TltW~lfllhi$•po&dfi~P 

~~ 

b Jam. I~ UC *•• ~ IFor b J.s ~ • ., .... .. c.--,.., 

t)_ \\t>Jdl.to....--

~ ------------------ bo~ 

- 1.0 

_., 

_, 

-u 

!1111 t.t.ttrt ,,,, 

:!tOO !® 1006 1'IXJit ZOU MIS 2018 

:-:.m: Th:l(ft.')nlkrlt!O~blu!doidlltlt~orll)~~ 

""""' Souc1: f« M ~~oOI'Iil, tNo:ul Rntrw 8owd,. ~ R~ 11, 

'"f--.'UII~ <illkl~S!m'":for~ lllwa.ol£~ 

~\-lb\ftAMI)11rrr.'\. 

t...:....___;_; 

~ l!IUt .:'tl! !el.l :116 l'CII~ 

\1m.~ arr t~ &. ~.ccd to }'Of-tO! nftP1101S 

~·~-~6\lml017'()4Dllll~l 

Sol.ttt: FC\Jml Rn."'Tit lk"'«'d. SUmigl IMc:a~ 2.1, "F~t~W.al 

M~ollkt..'ntlil:d~~ 
168 


71718023.eps

110 

: '\··~. 1\: · - lfi'\ -:. 

,. _ • .. - .. 

~~· Tllt M'!tii'I)Md,IJJt<:ll~l'J'W Wt il'l6t\~10 100 il 

tlN:rrtJ~~-II!t a.tbt ltt~ 

oiN'q ~~--faaif} ~IOptplk'«' .. ~ 

..., •• rc:wor ra-of'b <O »>~•-.••IIm-D)I6• .. 

" "'V Sroll'l ..... fN)., tdlptStnquCr~ 

---------------------~---

Ql 

21. S<k«<d """""'""of"" cl..., f""""~l for 

ooaf.-ial bu!ixs_"' 

lO 

.. 

lO 

A• -'HA-JLJLILILII~ IIJ t 

_,. 

It 1 I I t -· ll))) ))10 2012 201C :&It 

~WI f(d:nl RntM &.d. SIDIIcll l tbc' J I, -rNK'ill 

~clthtl..'liled

... while consumer confidence remains 

strong 

Consumers hare remained upbeat So far 1his 

year, I he Michigan survey index of consumer 

sentimem has been atcar its highest iel'el 

since 2000.1ikcly renecting rising income. job 

gain~ and low innation (figure 19). Indeed. 

households" e.~p«tations for real income 

changes 0\Cf abe next)ear or 1110 now stand 

above le\els prcteding a he pmious recession . 

Business investment has continued 

to rebound ... 

Investment spending by businesses has 

continued to increase so far this )"e"Jr. 1vith 

notable gains for spending, both on equipment 

and intangible$ and on nonresidential 

strudures(figure 20). Within strudures. 

abe rise in oil prices propelltd another steep 

ramp-up in imestment in drilling and mining 

stn•ctures-albeit not )et back to the le1~ls 

recorded from 2012to 2014-while investment 

in nonresidential structures outside of the 

energy sector picked up after declining in 

2017. Forward-looking indicators of business 

in1-estment spending remain favorable on 

balance. Business sentim~nt and the profit 

e.xp«tations of industf) anal)-sts ba1e been 

positiveO\·erall. 11hile ne~~ orders of capital 

goods have ad111nctd on net this year . 

. . . while corporate financing conditions 

have remained accommodative 

Aggregate ft011~ of credit to large nonfinancial 

firms remaintd strong in tbe first quarter. 

supported in JX!rt b) rdati1e~ lo-~· interest 

rates and accommodati1e financing conditions 

(figurt 21). The gross issuanct of corporate 

bonds sta)td robust during the first half of 

2018, while yields on both in c~tm and 

speculative-grade corporate bonds mored 

up notabl)' but remained low by historical 

standards (figure 22). Despite strong growth in 

business imesumnt. outstanding commercial 

and industrial (C&I) loans on banks' books 

rose only modestly in tbe first quarter. 

although their JX!ct of t'JXInsion in more 

rerent months has strengthentd on arerage. In 
169 


71718024.eps

April. rtSpe>ndents 10 1 he Senior loan Offictr 

Opinion Surrey on Bank lending Praclkts. 

or SLOOS. reponed that demand for C&l 

loans 11cakened in the lirsl quar1cr e1·en as 

lending standards and terms on such loans 

eased." Respondents auribUied this d~XIinc in 

demand in pan to firms dra11ing on imemall)' 

generated funds or using aherna1i1e soun:tS of 

financing. Mean11ftile. gnllllh in commercial 

rtal estate loans has moderated some but 

remains strong. In add ilion, financing 

conditions for small b~sincsscs appear 10 

ha1·e remained generally accommodatil'c, 11i1h 

lending standards liule changed almost banks 

and with most firms reponing that they are 

able 10 obtain credit. Although small business 

credit gi'OIIlh bas been subdued, suney data 

suggest this sluggishness is largd) due 10 

continued 11eak demand for credit b) small 

businesses. 

But activity in the housing sector has 

leveled off 

Residential im-estment. which rose a modest 

~ percent in 2017, appears 10 ha1t largely 

mored sidtll'a)~Orer the first fi1e months of 

the )ear. The sl011ing in residential in1ts1men1 

like!) is pari~ a result of higher mortgage 

intemt rates. Although these rates an: still 

lo11 by historical standards, the)' ha1e mo1ed 

up and are near their highest levels in SCI'en 

years (figun: 23). In addition, higher lumber 

prices and tig)ll supplies of skilled labor 

and dmloped lots reponedly hal'e been 

restraining home construction. While stans 

of both sing)e·fami~· and multifamily housing 

units ro;e in the founh quaner. sing)e·famil) 

stans ha1e been liulechanged, on net. since 

then. "hereas multifamily stans oonlinuoo 

10 climb earlier this year befort Hanening 

out (figure 24). Meanwhile. OI'Cr the first fil'e 

months of this year, new home sales ha1·c 

held at around the rate of late last year. but 

sales of existing homes hal'e eased some11 hal 

(figure 25). Despite the continued inertases 

in house pricts. the pact of construction has 

ll. ThtSlOOSis ;~~~il>bl< oo lltdloonl <b><IO :ot 

http;1~'••.f<ll<ra r<S<rl'e E'J\ datofsJoo,.' oos.htm. 

MOMTARY POliCY REPORT: MY2018 21 

_, 

- l - II - II 

~,~ ~ 

son: 'lk)"-ld& ...,..••~>"'WtOII. O.)ukoh. 

Soi.11Cr.: I('( W ot Al'll(tlo;• \krnll L)'Otb ~ ..S •lib 

-

- _-,.. 

IU 

- '" 

_,., ;-

-1-· I I I I I I I 

»>t ~u !Ot• Z~lf .2011 

,..., __ .... _ 

! I 

- u 

lJ....L..... ' X£6 ~ :!'OtO .!OU ~U !AI6 MIS 
170 


71718025.eps

..-.--

" 

6l " 

u 

!I 

,. 

H -

Itu-

,, -

----- .. - u 

ll 

- .. 

J....LJ J l\1)6 !(lOS ~10 !012 11)1.$ :cll6 !01$ 

~n· OM. J: ~·at:d<'IC'OJ1b• ~b ::OIS: ·~befar:-A.., 

~-~.WC\Xl' -ool)~okWts. '""'"""'""'-·""· · Sol••·forlle'ilo~~li.S. l'm!Wikn:IIK..,('l_,bl,ww: 

.. '-'-' ~ol~·\llf i.Mf.Wl}illl.'l, 

16 Clluov il rQ) illpx!s ad «ppil> ol"""' 

---

··-· ... ,_ 

-

---

-' 

- l 

_ , 

............. (,Of 

- l 

_, 

_, ' ','.I It I I I 

!\~'~.! xoa 3106 X(C ))It ~l :otn JliK :tlS 

not kept up \\ith demand. As a resuh. the 

months' suppl) of in1entories of homes for 

sale has remained at a relati1ely low level, and 

1he aggregale vacancy ra1e s1ands a11he lowes! 

level since 2003. 

Net exports had a neutral effect on GOP 

grow1h in the first quarter 

Afler being a small drag on U.S. real GOP 

glll'l1h last ym. net e1pons had a neutral 

effect on p1h in 1he fii'SI quaner. Real 

U.S. exporls increased abou1 3'h pertenlal 

an annual mlc, as expons of atllomobiles 

and consumer goods remained robust Real 

imporl gro111h slowed sharply following 

a surge !ale last )eaT (figure 26). Nominal 

1mde da1a 1hrough Ma) sug,_l!eSIIhat e.xpon 

groMh picked up in !he second quaner. kd 

b)' agricuhural C\por15. 11hile impon gfOIIth 

was 1epid. Alllold. !he 3\1!ilable data sugges1 

thatlhe nominal trade dcficillikely narrowed 

relative 10 GOP in 1he second quaner 

(figure 27). 

Fiscal policy became more expansionary 

this year ... 

federal fiscal polic) 11 ill like!) pfO\ide a 

moderate boos110 GOP p1h this year. The 

indi1idual and corporate tax cuts in the TOA 

should lead to increased priva1e consumption 

and inves1men1. 11 hile 1he Bipanisan Budge! 

Acl of 2018 (BBA)enables increased federal 

spending on goods and ser~ ices As !he eftocts 

of 1he BBA had yet 10 show lhrough. federal 

g01~mmen1 purthases pos1ed only a modes! 

gain in !he fi~l quarler (figure 28) . 

Afler naTTOIIiog significantly for !el'eral )tan. 

the federal unified deficit 11idened from about 

2Yi pertenl of GOP in fiscal year2015to 

3Yi percenl in fiscal201 7, and il is on pace 

10 move up further in fiscal2018. Ail hough 

expenditures as a share of GOP in 2017 

were rela!ively stable 3121 percenl, receipts 

mo,·ed l011er 10 rough!)' 17 pertent of GOP 

and ha1e remained 31 aboulthe same level so 

far this year (figure 29). The ratio of federal 
171 


71718026.eps

debt bdd by the public 10 nominal GOP "as 

16'!) perrent at the end of tiscal20 17 and is 

quite elel<lled relatiw to historical norms 

(figure 30) . 

. . . and the fiscal position of most slate 

and local governments is stable 

The fiscal position of most Slate and local 

go. emmems remains Slable. although there is a 

range of e.\perienctsacross these go.cmmtniS 

and some states are still struggling. After 

se•eral )tars of slow gro"1h. re1enue gains of 

state gol'ernmems hai'C strengthened notably 

as saks and income tax collections hal'e picked 

up OI'Cr the past few quarters. tn addition. 

house price gains have continued to push up 

property tax revenues at the locallc•el. But 

e\penditures by Slate and local go•emmtntS 

h:M been restrained. EmpiO)mtnt gM~th 

in this S«tor has been moderate, "bile real 

outla)S for conmuction by these go•emments 

ha1e largely been mo1ing side11a)s at a 

relatil'cly tow Jerel. 

Financial Developments 

The e\pOOed path of the federal funds rate has mo1 ed up 

Market·based mtaSures of the path of the 

federal funds rate cominue to suggest that 

market participants expect further gradual 

increases in the federal funds rate. Relatil'c 

to the end of last year. the expected policy 

rate path has moved up. boosted in part by 

imcstors' perreption of a strengthening in 

the domestic economic outlook (figure 31). 

In particular, the policy path m01ed higher 

in response to incoming economic data so far 

this year. especially the empiO)ment n:ports. 

11 hich 11~re seen as supporting expectations for 

a solid pace of growth in domestic etonomic 

activity. In addition. itwestors reportedly 

interpreted FOMC communications in the first 

half of 2018 as signaling an upbeat economic 

outlook and as n:inforeing expectations for 

funher gradual rtm01-al of moneta!) polic) 

accommodation. 

MOMTARI' l'Ol.ICY REPORT: MY20t8 23 

2$. C1aot<. raJ"" ......... ~ .. '"""""""'ondinl-

.......... 

- : _ , 

-· 

t 71 t j I I 

t~-~~ 

''""n..p lOt' ........ -"' ... f...t- ... ~prar&ntGDP).,Iiwfxto. 

~~•Q}.. «!GIJ. It\~llld~~ttf«llk 

llllllllhs~• \Lir,(i()Vtt.6tl'twqtof!Ol7:Q; W101SQ1 ltn"ripps i-'Cftditut(\lff• .,.~ks&s.. 

Sot.fi1: Off"' ofM Wid '~HI\'C'fAul)~ 

- It 

_,. 

- lO 

- 40 

"-= lk ..... .,... "--* ,.., tal',~.~ ..... '* Fo.inl lickkM.,..""' ..... Wi:l:ll4kt. T~~ 

adl •kdlftl~«~tGrill~~~w..~·­

ctld«lbtqiDM' 

Soulc'l:: f« (iOP.~of .«o.JmK ml)')H.\ ib\ft !at}til."),l.'lf 

~ ~ fCidml l Nft< t1o1n1 SUiutd Rcl-N Z.l. "f~l 

~od' L'11ki.! $U:c.~ 
172 


71718027.eps

--------------------~~~ 

) g 

~ " lOll 

\.Jn- bi' fcdml l'tle41'11t p6is ._-db)' oo0\ft$bi ladt\ 

.... a dtmJIM (O!Ilfl(t titd 110 tb.t tfrc.n11C' (akul W, '* llK II!IPIK'df*b IIJofJII)· 11.201l. iitUlf*cd,..O. ao ol~ N, 

:'fl1 1\t,..~.-·191Dr awrw~t.~·kftlrmol0'-- S.t•n """"'fal:nl~.tsmc: ""'-~ &w;-;14~ 

.... 

_, 

_, 

- s _ , 

' ·m. n.tT~ msod~ fltllt»rar~IWWlt} 

tmn• dllw)l l.~la::d "*ocra•Jct:..,f. ~ 

s. • o.,.-or6tT:~. 

Sul'\'()··bastd measu~ of the e~peaed path 

of the po!ic) rate 01er the next few years ha't 

also increased modeslly since the end of last 

year. According to the resuhs of the most 

rettnt Survey of l'rimary Dealers and Sumy 

of Market Participant~ both conducted by 

the Federal Resene Bank of New York just 

before the June FOMC meeting. the median 

of responderus' projeelions for the path of the 

federal funds rate shifted up about 25 basis 

points for 2018 and beyond. compared "ith 

the median of a=sments last December." 

Market-based measures of uncertainty about 

the policy rate approximately one to t\\'O years 

ahead increased slightly. on balance. from their 

lewis at the end of last year. 

The nominal Trtasury yield curve has 

shifted up 

The nominal Treasury )idd cum: has shifted 

up and flanened some,. hat further during the 

first half of 2018 after flanening considerably 

in the second half of 2017. 1n particular, the 

yields on 2- and 10-year nominal Treasury 

~unties increased about 70 basis poirus and 

45 basis pointS. respccthcly. from their ~~~Is 

auheend of 2017 (figure 32). The increase 

in Treasury yield> seem, to largely reflm 

im-estors' yeater optimism about the domestic 

growth outlook and firming expectations for 

further gradual remo\'al of monetary policy 

aceommod:uion. Expectations for increases 

in the supply of Treasury s..'Curitie.s foll01•1ng 

the federal budget agreement in early February 

also appear to ha\e contributed to the increase 

in Treasury yield~ "hile increased concerns 

about trade policy both domestically and 

abroad. politiall d~elopments in Europe. 

and 1he roreign economic ou1look weighed on 

onger~ated Treasuf) yield1 Yields on 30-year 

agency mongage·backl-d securities (MBS)-an 

important determinant of mortgage interest 

t3. Tht r<>utt> o( th< Sun"l or Prim:ol)' D<al<ri 

and do• Suney o( \11rte1 P>ruapws m :n-.ilalik 

ooth<FcdmiRtstn<B.tnl: od''\'" \'od:S.'CioiittOI 

p>J;Iln- ortfcd.orpln:uL«>pnmll}d<:lkr_ 

!111\')_qu.stion, html>od hllps;/•"'"'·""'1ortf<d.O<JI 

1113rk&'>Uf\t) 1113rl<t..pan<ip:~nt>. "''l'<ti>'* 
173 


71718028.eps

ra1es increased about 60 basis poin1s owr !he 

find half of 1he year. a bi1 more !han !he rise in 

1he 10·).-ar nominal Treasury yield, bul remain 

low by hi110rical sland.ards (figure 33). Yields 

on corpora1c dcb1 secu.ri1ies-bo1h in"es1mcm 

grade and high )ield- rose more 1han Treasury 

yield~ leil\ing !he spreads on corpora1c bond 

l ields 01er comparable-maiUrily Treasury 

)'kids no1ably \\ider tban a11he ~nning of 

!he )ear. 

Broad equity index~s ros~ mod~tly amid 

some bouts of market volatility 

Aflcr surging as much as 20 percelll in 2017. 

broad s1ock marke1 indexes rose modcslly, 

on balance. so far I his year amid some bouls 

of hcighlencd volalilil)' in financial markels 

(figure 34). The boos11o equil) p~ from 

fir.d-quaner earnings repons 1ha1 generall) 

beal analysis· e.'pectalions was reponedly 

offse1 by increased uncenainly abou11mde 

policy. rising imeres1 rates, and conctrns 

about polilical de1-elo1)ments abroad. While 

slock prices for companies in the !ethnology 

and consumer discretionary sectors rose 

no1ably. those of companies in I he industrial 

and financial sectors dedincd modes1ly. After 

spiking considerahl) in ear~ Februar), the 

implied 1ola1ility for !he S&P 500 inde' 

tht VIX~eclined and ended the period 

slighlly above 1he low levels 1ha1 prevailed in 

2017. (For a discussion of financial s1abili1y 

issues. see 1he box '·De1·elopmems Relaled 10 

Financial S1abili1y.") 

Markets for Tr~asury stcuriti~, mortgage-

~d~ ~riti~, and municipal bonds 

ha1 e funct on~ well 

On balance. indica1ors of Treasury markel 

funelioning remained broadly s1ablc over 

1he firs! half of 2018. A l'llriely of liqt1idi1y 

mc1rics-induding bid·ask spread~ bid si1.es. 

and e:.1ima1es of 1ransae1ion COSIS hal'e 

displayed minimal signs of liquidily pres:.ures 

0\CraiJ, "ilh lhee.,ctp!ion of a britf period 

of redUctd liquidi1y in earl) February amid 

eiCI'31cd financial market 1ola1ili1). Liquidil) 

condi1ions in I he agency MBS markcl were 

MOMTARY POliCY REPORT: MY2018 25 

- -·-

"' 

- ·~ 

ll - - . -..:m~lbcO.Ut«d&.i ~ Y~ld ihollt1. f'ot tbtfatlfti.:o "'-:~ 

nnt«~ilk~l'l&c••W~n~«<!i«WWtln 

ti0116dk pnMI• ptt.« '"'· ,. SprQI~'IIIiilttG.:»mttd'dlt 

5- a:il .. rc•.-..TmNII) )dk. nt.-a..m~Jif) II, ,,. 

Sou,, ~t(dltTICW).Ia'<~'-

lOO 

m 

,., 

- " - ,. 

- ll 

,,,, :UD X01 ~ :006 ~ 0 Mil MU 1016 II 

Sol.m!~~~lb.lonN. 'il IFor l);)oll 

JeM I'ldl.:uh.~·rot!UIIftl,ta:Chtnte.tOD!k('«~~MJpltt ) 
174 


71718029.eps

Developments Related to Financial Stability 

The U.S. fioancial system remains subolantially mo<e 

re;ii~~IIM~ duri~g I~ ~l~ bel~ t~ fiMollial 

crisis.' Vdlr.tations continue to be e1ev.ated fOI' a range 

oi assets. rn the pti\tJte nonlin.anc.ial sector, the r<~tio of 

tool d<btto gross domeslic prodU<:l !GOP! is a boot in 

line with an ~imate ol its trend, and vulnetdbilities 

associated with ~ rem.1in moderJte on balance. 

While borrowing among hi~hly lel-ered and ~q,,~. 

rated firms is ele\'.ated and a future weake-ning in 

L'O)fl()l1lic activit)' could ampli~1 wme wlner.1bilities 

in the corpor.te ~tor, the ratio ol housdlold del~ to 

dispos.lble income h.Js remained stable in recent ~~ars. 

Vulnffi'lbi1ities associ<tted wilh !e"erage in the financ:ial 

sector appear to.v, reflecting in part strong capital 

po>itions ol banks. How.,.er, sorne measures ol hedge 

fund 1"'-erage hil\~ increa>ed. Vul"""bilities associ"ed 

with maturity and liquidity transfCM'mation continue to 

be low corn pared with lel.-ls that generally prMiled 

before 2008. 

Valuation pressure-s in \'arioos asset markets 

remain el.,.•ted b)• hillO<ic•l ~andards, although 

they have ~lined """"''hat since the ~art of the 

~~ar, as corporal£ bond prices h.Js~ fallen and higher 

earnings ha\-e hetped ratiomlize equity prict>S. l\o\ad.:et 

ffiO\-tments were outsized in Februa.ry, around I he time 

of the prtl\•ious MOI>Iltary Policy RRport. Since then, 

\OOtili~· h.Js receded, although it has ended up ~ightly 

above the low le,~lsseen in 20t7. Even with higher 

e>peeted earnings due in port to changes in Ia< law, the 

fomord <Guity price-to-earnings ratio fe< the S&·P 500 

remains in the upper end oi i~ hi~orical disuibution 

!figure A). Treasury term premiurm ha'~ increased 

modeslly from the beginning of the)~" but remain 

to.v relati\~ to histori<ally obse<ved '~lues. Corpotate 

bond )'ields and their spreads to yields on comparable· 

maturityTreasury~urilies f't{l\"e increased no1abty, 

but they continue lO be to.v b)• hi~orical standard~ In 

particular, spe<ulati,-e-gr.Mie rields and spreads lie in 

the bottom fifth and bottom fourth of their respecrive 

historical disrributions.tn le-~raged loan m.1rke'~. 

issuance has been robust. spreads hil\~ re.!Ched their 

""'~ 10\~ls since the fonancial crisis, and the presence 

olloan r:m~nB has ~reased further. In real estate 

1._ MO\«vitwcltheframeworkfor.,..,;ngfiooncol 

stAbil1ty 1n 11'1e United St.lt('S is pcovidro in l~ Br<Jitwd 

~Ot81, "An Upru:eOClthe f«<«at ResEnt's finaocial S..bili~ 

Ag<od.l; !pet<h rkl'««<atrheCoo:er for C!ob;l !cononl)• 

.wd Bu5.iness, Stetn School of 8usinl"!os, N'ewYM: Univmil\', 

~ewYork.A¢13, lmps.1Mww.fedetJ!resen-e,g(rdnf'l.~~ff.tv 

spet<h1lraiNrdl018040Ja.hrm. 

A. forward price·t0oe3Jflings ra1ioofS&:P 500 finns 

... 

- JO 

-1S 

- lO 

- ro 

- s 

~lkO..Ocplct(t!.:~crot-."WPf".~~rUot 

WXOfir!M.Th:~D!'Ibllsbt:$fdtalht.afrQCIII'meolh..• 

pt6(ftl~Nrl~ptfll'Jsofr~as&fllllo.'\lbyWNJI:KCW 

ikmool£maom~R(k&il. DlllJ«b&'llti!OCII!~C'\f'o.'~ 

""""'"'"""" ~"l(l!SufT'~~coT~R~IB£$.. 

m.1rl<ers, cornme<ei.ll property \Oiuations continue to 

be Wetched. Capitali,.tion rates (computed as the ratio 

of net operating income relati,eto property values) 

rem.1in low, and, in recent quarters, their sp~~ds to 

yields on 1 ().J~r Treasury ~urities h3\-e ..,..o down 

consider~blr ~Rilll)~ -.lu.11ion pressures in resi~tial 

r"l eslate m.1r~e~ increased modesll)·· Aggregate priceto-rent ratios, adj~ed for an ~irna1e of their long-run 

~end and the carrying~ of housin~ are approaching 

the cycle peaks olthe early 1980s and early 19901 but 

remain "~II beiO\v the 10\-els obse/\.0 on the.,. .. oi 

the ilnanciC~I crisis. 

1\'tth households and busines>es token togerher,the 

ratiooltotal ~to GOP is about in line with estim.1tes 

of i~ uend, although podret> ol stress are l?'i~t. In 

the household sector, the ne1 expansion of housdlold 

debt has been in line wilh income gr~)'l\1h and is 

conceotr~ted among prime-ritted borrowe-rs. Ho\\'e\'ef, 

deli~uertey rates for sorne forms of consumer credit 

hal~ 010\'ed up, ~ing rising strains among riskier 

borrO\\-e/Se\~ with unemployment '"el\' IO\,•.IIanks 

are reportedly tightening standards on credit card and 

auto loans. In the nonfinancial business sector,ltl\~e 

of corporate busines>es remain; high, as indkated by 

a po>iti'~ ~toral crediHo-GOP gap. Net issuance o1 

riSL)• debt has. riset~ in recent quarters, mainl)' dri\·en D)· 

the growth in 10\.,.agOO loans (frgure B!. While current 

(con!irwedJ 
175 


71718030.eps

8. TOE3IIltlissu>DC<ofrisky<l.-bl 

- 00 

- (<!) 

_,. 

_., 

_., 

_,. 

.\00: '*' l:t"~ 1110\1118 fl~tAdt\\:1'16~ ))J$.-W, TOblo.1~ofrisl)&btiS41.:-~ofrb.!r.d~Of 

Sf"\'1lbli\{'-p.k101utemlboo.k2tldk;~--

Sc:u:n: ~~ rt,Ciilroblmaii.Sti.~Dallttir.S&I" u..~ 

""""""'rl"'"-

CotpOiate credit conditions are f.l\'Oiable O'l<'fall, 

with low int«esl e>penses and default>, the elel>ated 

le\'e1'age in this se<.101' coufd result in higher future 

default rates. In addition, weak p<otec:tion from loon 

CO'I'enant> could reduce early inten~ntioo by lenders 

and ""'"' recO'I<'f)' rates for im-e<too on default 

lnvestOIS may also be el.p()Sed to signifiCant ep~icing 

risks bec:au~e bond yields and credit risk p<«niums are 

bothiO'Iv. 

Vuln«abilitie< from financial-sector '""''&• continue to be relativ-ely low. Coce flnantial 

intetmediilties, including large banks, insurance 

companies, and broket-doaler;. 3J'P"" well positioned 

to weather economic stress. Regulatocy Cetpilal •atios {Of 

the global l)'<lemically i mpo<tlnt banks h.n't remained 

\\~II abo\~ the lull)• phaled·in enh,10ced r<gulatory 

requiremen~ and are d01e to hi~orical high~ Capit>l 

1",.'' at insufdnce companies and lnok«·deal«> 

also r«nain relati\-elr ~ by historical ltandardl. 

H"''"'"'· some indicators of hedge fund '""'age in 

the equity marke~ ""'h •• the provi1ion of lola! margin 

crediuo equi~· invesloe<. h,we risen to hi~orically 

eiO\•ated 10\-.ls, and in the pa~ iO\\• qua~«> deal«s 

ha,,. reportedly ea...!, on net, price terms to their 

hedge fund client>. 

The resulu of wper\<iSOI)' wess tes~ relealed in June 

b)• lhe Fede<al Resen-elloard confirm that the notion's 

Llrgest banks are wongly capi~lized ;nd would be 

able to lend to houstho!ds ,,nd businesses""" during 

MONEIARYI'OUCYREI'ORT: JULYI018 27 

a 50\ -ere global recession.' The h)')lolhetical '"'"'ely 

a<h-· !t~n.lnO-t~ li'oO!t wintMt !t~atio 

ret .led in lhe Board's wess tesll, \\ith the u.s. unemployment r.ne rising almost 6 pe«entage poin~ to 

I 0 pe«eot-proj~ S578 billion in total losses fO< the 

35 panicipating bani> during lhe nine qua~e<s tesled. 

Since 2009, thole Rrn~ h;n-e added about $800 billion 

in common equity capit.11. The Board also 0\•;luates the 

capital planning p<OCesses of the participating banks. 

including the firms' planned capit.ll actions, such as 

dividend parments and !hare bo)1>lcks.' The Board did 

not o!Jioo to lhe copital plano of 34 firn11. Although 

the recent U.S.t<IX legislation is expected to increa<e 

bank( post·t.J• earnings, and hence their abili~· 

to accrete capital, it did !<ad to one-time losses. 

deueasingbanks' capit.11 ratios atlhe end of20ti, the 

jumping-<>ff point of the wess tes1S.In part bec:a01e 

of these effect<, evident in te>rt figure 36. ~\1) firms 

were required to maintain theit caplt.1l disllibutions 

at the 10\-.ls they paid in recent yea~. Separately, one 

firn1 \\ill be re<1uired to address the management and 

anal)'is of its counterpart)• exposure under stress. The 

Board objected to the capital plano! one bank bec:au~e 

of qualitative cone ems. 

l'uln«abilities associated \\ith liquidi~· and 

mawrit)• lr.ansfotmation---{hat is, the financing of 

illiquid assets or long· maturity assets \\ith shor1· 

m<~lutit)• debt-continue to be !0\ ~ owing in part to 

liquidity r<gulations for banks and money market 

refor-m. large baoks ha-. wong liquidity positions, 

bec:a01e their ""'oi core deposits as a sourte of 

funding and their holding> of high-quality liquid 

assets temain neat historic.al highs~ \\'hile their use of 

short·tefm wholesale funding as a share of lidbilities 

is~~ historiCAl! lows. Since the rn<>ne)' market fund 

refor-ms implemented in Octobet 2016, as~elS under 

ma.,gemcnt ot ptime fundi, iflllitutions that ptO\W 

wln«Jble to runs in lhe past. ha\~ retnained far l>eiO'I'' 

pte-reform 10\-els. In addition, the 8'"''1h in al:ernati\'t 

short·tetm in\estnle01 \'ebides, which- may htwe some 

(cor>~nued oo nex1 page! 

l. S..SoardofG<>...,ofthei'<de<aiR"""~S"""' 

i20t8l. ·f<de<aiRe<trwl!o.!rd R!'lt""' R'"'l" of~i""Y ~rd: S!res.sTests,'" prtSS refe.ase, June 21, https1Mww. 

ieder<J~tien"t,gorlntwSE'\~ts.sreleasesl 

lxff8W18061ta.t.m. 

3. S..Bo.!rdofG<>""""oflhei'<de<al Resen~Sy•em 

t20t8•, ·f<de<aiR.,.,~ R!'ltasesResuhsof~~ 

upila1Mllr%and Re\ie-viCG\RJ; P"s' release.lune19, httpsiAw .. w.fedef.alreservt~·Jnew~atn!i')xess.rele.J:SeS/ 

bcregrol !0629a.lllm. 
176 


71718031.eps

Financial Stability (ccori~>wd! 

similar \'Uinerabillti~, continues 10 be limited, ~s 

in.O<lor> ""'~ shifted p<inwil)' from p<irne fuM< into 

g<l'<rnmtnt funds. 

Risks from abroad are moderate 0\'<fall. Ad\om 

foreign e<:ooornie< (llfEs), many of which ha\-e 

signifocanttlnanci.JI and ,..I linkages to the United 

S~:es, conbnue to have nolable or ele-.ted v•luations 

in some .asset markets and. in a few coonu-ies, high 

le\-els of household debt relahve to COP. These 

fdCloo ha\~ conviooted to some AFEs onnooAcing 

or implementing ,..croprurlential actions. including 

increases in counterr;ydkal capildl ooff.,, 0\'eflhe 

p.llt couple of)~~. More ;gene,.lly, AFE financial 

sectors contiAue their siO\v pace of dele\-er•ging 

th.lt staned aiter the global financial and euro-arca 

SO\oreign debt crises. In a<ldition, low corpo<ate debt 

spreads in the p.11t few)~'"""'~ )~tto vanslate 

into an)' m<~rked iocrease in te\-erage in most of these 

countries' nonfln.andal COff>OJate sectors. Some major 

emerging ,..Ike; e<:ooornies conbnue to h.l!bor 

rno<e pronoonced vulnerabilities, rellecting some 

combination of the foiiO\ving: substantial corpo<ate 

l~'efage, fiscal concems.. Of E"xcessi\'e ,e-Jiance on 

foreign funding. Global I)•. po:ential dO\vnside ris~s to 

international fi..,nci•l ""lltets and financial stability 

include political uncertainty, an intemification oi ttdde 

tensions, and challenges posed by rising intere<t r.ues. 

The countercyclical capildl buffer (CCy81 isa 

m.lCroprudentialtool the l<de<al Reser\~ Board call 

use to increase the ~lieroceofthe financial sy>tern 

by railing capit.tl requirements on lhe largest banks. 

Acti-.ting the CCy8 is appropriate "ilen S)'Stemk 

\'Uinetobilities are meaningful!)' abo\'e normal.~ The 

Board is cl<ll<l)' monitoring the le,~land configuration 

of 'l"en'ic \'Uinerabilities descrihed ca~ier. 

4. SeeBo.udof<A.<1nMoltllefede<•IRe«r\~Sy•om 

12016!, ·Rogu\Jtory Upi~l Rules: The Fede<•t R-• S..,<fs 

r,.,....,, for lmpiem«<:ing '""u.s. s.!<!l 111 C..nt«q<r~•t 

Upilal Bufle<; fifi.Jt policy """""'t{il<rlet No. R·l S29), 

l«<<r•l ~· , .... 3tlSept"""" to). pp. 636$2-83. 
177 


71718032.eps

also generally stable. Overall, the functioning 

ofT reasury and agency M BS markets has not 

been materially affected by the implememation 

of the Federal Resem ·s balance sheet 

normalization program. including the 

accompanying reduclion in reini'CSimenl of 

principal pa)1nen1s from the Federal Reserve's 

securities holdings Credit conditions in 

municipal bond marke1s haw remained stable 

since the tum of the year. 01-er that period. 

yield spreads on 20-year general obliga1ion 

municipal bonds over comparable-maiUrity 

Treasury securities edged up a bit 

Money market rates have moved up in 

line with increases in the FOMC's target 

range 

Conditions in domestic short-term funding 

markets have also remained generally stable 

so far in 2018. Yields on a broad set of money 

market instruments moved higher in response 

to the FOMC's policy actions in March and 

June. Some money market rates rose during 

the first quarter more t.han what would 

normally oceur with monetary tightening. 

For example. the spreads of certificates of 

deposit and term London interbank oft'ered 

rates relative to overnight index swap (OlS) 

rates increased notably. reportedly reflecting 

increased issuance of Treasury bills and 

perhaps also the amicipated tax·induced 

repatriation of foreign earnings by U.S. 

corporat on~ The up1vard pressure on shortterm funding rates, beyond that driven by 

expected monetary pol icy. eased in reoent 

month~ leading loa n;~rrowing of spreads 

of some money market rates to OIS rates, 

Ho11-ever, the spreads remain wider than at the 

beginning of I he ~r. 

Bank credit continued to expand and 

bank profitability improved 

Aggregate credit provided by commercial 

banks continued to increase lhrough the first 

quarter of 2018 at a pare similar to I he one 

seen in 201 7.11s pare was slower than that of 

nominal GOP, thus leaving the ratio of total 

commercial bank credit to current-dollar 

MONEIARYI'OUCYREI'ORT: JULYI018 29 
178 


71718033.eps

35. R.acioofc01al romi"Jl(fCial ~nk rn.'dit to norninal gross 

domeslk prodoc1 

- - i.S 

-» 

1 It I I I! I II I I 1 I I 1! I I l J 

l'OOO Z00!~2():)6,X(IS !0102:012 :0014 2GI~ZG S 

Sort«.: F<'lin3 ~'t BttW. ~ Rd:N HJ. ·As5ru »d 

~oiC«rm."!NNIbnksintb:-U~~"':Ikt.:.of~ 

A»>));is, J.JH.NfAnai)1Jr."$.. 

36. rofl1abi ~· of bank holding too1panies 

lJl -

IJ - ~~~~~ 

u -

5 -

5 -

u -

IJ -

1..0 -

!1 I It !IJ I!!!! 

- JO 

_,. 

- 10 

_,. 

- JO 

2IXKt !'001101)1 2006 b:OS 1GIO 1'012 ZOI" 1'016 2018 

n: lb:dlti~U~¥!4il' ~!)~~(li 

Sol.n Fc&nl t Ran fcm FR \'-9C. C~ Flt\Wial 

SW<o=f«lllel.I"""'C_,_ 

37. Equi1y indexes for .,t,~lod fO«'ign «<OllOIIios 

- IJO 

_,,. - 110 

- 100 

.. I It.! I! t I. t I I!! I I j 

!IllS 2'01, ZOI1 ))JS 

SOT!: 1k dau :we .,.-ffit)' l\~ of daly &:.1 MtJ ('lj(f)j ~ 

Jui) IUOI&. 

SQ..-.u; F«cwo.-a W EaS.:.,...\-.; l~:i«"UIIIl<'IJ ~F'TS$ 

100 ~i: o&:~: b nn.,P. IIJiri:ct~ MSCl Uo..,P. ~ 

lcaiCwt<O.-yll).\:\;~ ~~ 

GOP slightly lower than in the pre1•ious year 

(figure 35). Available data for the second 

quarter suggest that gr0\\1h in banks' core 

loans continued to be moderate. Measures of 

bank profitability improred in the first quarter 

of 2018 after having experienced a temporary 

decline in the last quarter of2017. Weaker 

fourth-quarter measures of bank profitability 

were partly driven by higher write-downs of 

deferred tax assets in response to the U.S. tax 

legislation (figure 36). 

International Developments 

Political developments and signs of 

moderating growth weighed on advanced 

foreign economy asset prices 

Since February. political developments 

in Europe and moderation in economic 

growth outside of the United States weighed 

on some risky asset prices in advanced 

foreign economies(AFEs). Interest rates on 

sovereign bonds in SC1-eral countries in the 

European periphery rose notably relative to 

core countrie~ and European bank shares 

came under pressure, as in•-estors focused 

on the formation of the Italian go,·ernment. 

Nonetheless, peripheral bond spreads 

remained well below their lerels at the height 

of the euro-area crisis, and the mol'es partly 

retraced as a gol'ernment was put in place. 

Broad stock price indexes "~re little changed 

on net (figure 37). In contrast to the United 

States. long-term sovereign yields and market· 

implied paths of policy rates in the core euro 

area as "~II as the United Kingdom declined 

somewhat, and rates were little changed in 

Japan (figure 38). 

Heightened investor focus on vulnerabilities in emerging market 

economies led asset prices to come under 

pressure 

tm•estor concerns about financial 

vulnerabilities in sewral emerging market 

economies (EM Es) intensified this spring 

against the backdrop of rising U.S. interest 

rates. Broad measures of EME so1~reigu 
179 


71718034.eps

bond sprtads Ol'ct U.S. T rtaSUT)' )ields 

11idened notably, and benchmark EMEequity 

indexes declined, as investors scrutinized 

macroeconomic policy approaches in se1-eral 

commie& Turkey and Argentina. which faced 

persistently high in Hat ion. expansionary fiscal 

policies. and large cur~nt account deficits. 

1\(re among the worst performer). Trodc 

polk)· de-dopmcntsbetwcen the United 

States and its troding panners also 11righed on 

E~t E a&~et prires. especially on stock prices 

in China and some emerging Asian countries. 

EME mutual funds saw net outfl0111 in May 

and June after generally solid inflo\\S earlier 

in the year (figure 39). While mo1cmcnts in 

asset prices and capital flo11~ "~re notable for 

a number of economies. broad indicators of 

financial stress in EMEs remained 1011 relati1e 

to le\ds seen during other periods of stress in 

rcctnt )"ears. 

The dollar appreciated 

After depreciating during 2017, the broad 

exchange l'alue of the U.S. dollar has 

appn.'Ciatcd moderotely in recent months 

(figure 40). Factors contributing to the 

appreciation of the dollar likd) include 

modmting gr0111h in some foreign economies 

combined "ith continued output strtngth 

and ongoing policy tightening in the United 

States. do11 nside risks stemming from political 

dc1<elopments in Europe and sercrJI EMEs, 

and the recent de\'clopmcnts in trade policy. 

Sereral currencies appeared particularly 

scnsiti1c to trade policy del'elopments, 

induding the Canadian dollar and the 

~k<ican peso. related to the Nonh American 

Free Trode Agreement negotiations. as well 

as the Chinese renminbi. which fell nolably 

against the dollar in J~ne. 

The pace of economic activity moderated 

in theAFEs 

In the first quaner. real GOP growth 

dereleroted in all major AFEs and turned 

neg:uile in Japan. d011 n from robust rotesof 

actirit) in 2017 (figure 41). Pan of this siO\\ing 

is a n.-suh of temporory factors. though, 

M().\EIAAYPOXV I'ORT: MYl0t8 31 

lt ._....,.tO.)<ar pCftll<!llbood!i<ldsiD 

l<k<W ""''IIC<d C<ODOOii<s 

10 

lJ 

!. 

-u 

- ,. 

- J 

-- ......... , .... 

1: lllt- and~'-61\owdaa.a ~t qunctt)'5111Mof•MI)· 

dU timll.nut) .201~. '0 .W\il )l,20 &. illdmoolbly ... ol•MI)· 

d3bf A;al 1. 201~ 1011rlt)O, ~I B ThtfBJ!bl:s41Un.ct.k(IDh 

-a... Tbr JP S.,"q.W~f .... MJdttsBoodlD&_ ~ 

(l\lEIJo ... lrC' .. ml)' :t. (1"1~dlbd) 4lu -~"tid ltmiP Jut)' . ,~ 

Sot.IU; ,.,..,*.., ,_,.,..),unc.wcliwl\181·. 1' 

-~""""-""'""'•8loooloi 
180 


71718035.eps

40. U.S. dollar exchange r.Jt~ indexes 

- ~ 

Non: fh:4#1.•hidlaxa~CVT~X~.."Yu=spt6cltbJ •~'~tr 

~"""'old>Oy"'"ID!"'-""""'''>"I)' II.lO tM<O<..-.!b)d. 

~inlhtcW~US.cl-a.IJ'S('~m:ldc\-r &-S 

""""'V.S."""""""""" Sot.«t: Ftd..'nl R('SCr\'t Jbrd. ~ Rc\cw' H.IO. "f~ 

'""""'"'"'" 

4t. c;llgrossdom<s<~pr<J<flJclp1bi sck<l<d 

ld\"ilnoo.. roreign ec-onomies 

--- .

•""'"'-

,.., • EuroJ;:t~ 

• c..o. 

lO" 

-s 

_ , 

-1 

-I 

- I 

2016 lOll lOIS 

Sollt(t; tklini'.N ~Olrt«kc ~5:1tist)..,. f« ~ 

CJlO.'IO!l"~« Go o.'!1m.'CIIIothpD:tcw-tbtCua:~w:;.t~r ...... c-*. 

~c_..n il b\~ ~~ 

including unusually cold weather in Japan 

and the United Kingdom, labor strikes in the 

euro area. and disruptions in oil production in 

Canada. In most AFEs, economic indicators 

for the second quarter, including purchasing 

manager surreys and expons, are generally 

consistent with solid economic growth. 

Despite tight labor markets, inflation pressures remain subdued in 

mostAFEs ... 

Sustained increases in oil prices provided 

upward pressure on consumer price infiation 

across all AFEs in the first half of the year 

(figure 42). However. core inflation has 

generally remained muted in most AFEs, 

despite funher improvement in labor market 

condition~ In Canada, in contrast, core 

inflation picked up amid solid wage gro11~h, 

pushing the total inflation rJte above the 

central bank target. 

... prompting central banks to maintain 

highly accommodative monetary policies 

With underlying inflation still subdued, the 

Bank of Japan and the European Central 

Bank (ECB) kept their policy rates at 

historicall)' low levels, although the ECB 

indicated it would again reduce the pace of 

its asset purchases starting in October. The 

Bank of England and the Bank of Canada, 

which both began raising interest rates last 

year, signaled that further rate increases will 

be gmdual, given a moderation in the pace of 

economic activity. 

In emerging Asia, growth remained 

solid ... 

Economic growth in China remained solid 

in the first quarter of2018. as a rebound in 

steel production and strong external demand 

bolstered a recovery in industrial activity 

and overall growth (figure 43). Indicators 

of investment and retail sales have slowed 

in recent month~ howe·m. suggesting that 

the authorities' effort to rein in credit may 

have softened domestic demand. Most other 
181 


71718036.eps

emerging Asian economies registered strong 

gro11'1h in 1he firs! quaner of 2018, panly 

reflecling solid ex1ernal demand . 

. . . while growth in some Latin American 

economies was mixed 

In Mexico, real GDP surged in 1he firs! quaner 

as economic acli,;ly rebounded from 1wo 

major carlhquakes and a hurricane las! year. 

Following a brief reco\'ery in I he firs! half of 

2017, Brazil's economy Sial led in 1he fourlh 

quaner and grew lepidly in 1he firs! qua ncr. 

and a lntckers' mike paralyzed economic 

aclivil)' in !ale May. 

MONEIARYI'OUCYREI'ORT: JULYI0t8 33 

42. Consumer prire inRa[ion in scl«tcd 31.1'-aoc«t foreign 

C\."00011l.ics. 

-· ·-·- - J 

- l 

_, 

- I 

1 I I I I I I I I I I. I I I 1 

20lS 2(116 Wl1 S 

;.;on 'fb:&-.J:(Ot~C\IIO~~~ftWINZirtu~(«J~ 

Mt~n.«u"'c.,.,_.,..,~.,..~,-~ 

~ !OIS. 

&;.,,:10: F«tbtl.~ ~Offi,.~IOt~S&a:istits:f<w~ 

lmis.tr)ofi~AffM.~C~..UOOS:kc'ckCW\la:t&, 

~<~ OO"~Ctt!itkEwopt.-C~fortw.i.l.Sbti.il).'5 

C.-h:;all\illb\ttrAIQI)ta."s. 

4). Real gross dom<stic product gMAl h in S<i«led 

'fi'ICrg.ing ll'l.11Xct ttOnomies 

I Clio> • K(m 

. Mrt.ieo 

I &.ol Ql 

:0014 201S 20'16 11)17 :'018 

- 12 

- J 

- J 

\Ott~ Th:dlltaf«OiRallc~ a6juib!~ bdd'Jhcd)Q 

I«K«t<~, \]tt;a.,JOJb *'t~ adjw..'l!~lbrit~'tft~ 

J(I\\TM'ICI:I.~ 

Sol.'ltt f«(li:la.ChiniN~Bimiool~ies::IOr OI'Q.Sri: 

of ON:(b~ ruro.I.D$tiMo~dt&tklb1it.l)~ll:f« 

Brdlt~SU~It.JO&Iiiklro&~ut8&auslk&;al\lalb\('t'Aml)ti."s. 
182 


71718037.eps

PART 2 

MoNETARY Poucv 

The Federal Open Market Committee 

continued to gradually increase the 

federal funds target range in the first half 

of the year . . . 

Since December 2015, the Federal Open 

Market Commiuee (FOMC) has been 

gradually increasing its target range for 

the federal funds rate as the economy has 

continued to make progress toward the 

Commiuee's congressionally mandated 

objectil-es of maximum employment and 

price stability. In the first half of this year. the 

Commiuee continued this gradual process of 

scJiing back monetary policy accommodation, 

increasing its target range for the federal funds 

rate V. percentage point at its meetings in both 

March and June. With these increases, the 

federal funds rate is currently in the range of 

I¥. to 2 percent (figure 44)." The Commiuee's 

decisions reflected the continued strengthening 

t4. S.. Board ofGo,<morsofthe Fodera! 

Re;cmSyst<m(20t8). "fedtrnl osc ssucs 

O~IC Stat<m<nt.'' press release. Man:h 21. htt(IO:i/ 

ww. ral~rvc.go, ne Sc!wnts/pressre ascY 

mon<tary201S0)2ta.htm: and Board of Gowmo,.of 

til< Fedcrnl Re;cn< Sl""" (lOtS). "Fnlcrnl "" < 

ls;ucs FOMC Statement." pres$ 'lease. Jun<: IJ. hu(IO:i/ 

ww. OOer.tl~ne .. go\·/ et\~\' sfpressre eaSc.W 

montlary201S061.h.hun. 

of the labor market and the aocumulating 

evidence that, after many years of running 

below the Committee's 2 percent longerrun objectil'e. inflation had mol'ed close to 

2 percent. 

... but monetary policy continues to 

support economic growth 

35 

Even after the gradual increases in the federal 

funds rate Ol'cr the first half of the year, the 

Commillee judges that the stance of monetary 

policy remains accommodatii'C, thereby 

supporting strong labor market conditions 

and a sustained return to 2 percent inflation. 

In particular, the federal funds rme remains 

somewhat below most FOMC participants' 

estimates of its longer-run value. 

The Commi11ee expects that a gradual 

approach to increasing the target range for 

the federal funds rate will be consistent with 

a sustained expansion of economic activity, 

strong labor market cond tion~ and inflation 

near the Commillce's symmetric 2 percent 

objective Ol'tr the medium term. Consistent 

with this outlook. in the most recent 

Summary of Economic Projections (SEP). 

which was compiled at the time of the June 

FOMC meeting, the median of participants' 

- l 

-· - ) 

_ , 

_, 

- 0 

It I I I I I I I I I I! I I I I I I I I I I I I I I I I I I I I! I I I I I I I I 

2Im 2009 2(110 lG\1 Z'Oll 1'0U 20!4 :'GIS :'016 l0l1 2018 

!\olt: Tbe 2- 't*'~ ~'t'#Tt~111!e~o~ tht ~.f!'lllll.liJY)idds~cotbtt:IOSiani\'tty ai~ 

SoliO': ~ofrbe-T~~ roctal ~c8QW. 
183 


71718038.eps

36 PART2: ,\ION!TAAY 1'0\«:Y 

assessmems for the appropriate le1•el of the 

target range for the federnl funds rate at 

year-end rises gradually over the period from 

2018to 2020 and stands somewhat above the 

median projection for its longer-nm level by 

the end o( 20i9 and through 2()i().

1

S 

Future changes in the federal funds rate 

will depend on the economic outlook as informed by incoming data 

Tlte FOMC has continuod to emphasize 

that. in determining the timing and size of 

future adjustments to the target range for 

the federal funds rate, it will assess realized 

and expected economic C<lnditions relative 

to its maximum-emplo)ment objective and 

its S)OJlmetric 2 percent iaftation objective. 

This assessment 11 11 take into aocount a wide 

range of information. including measures 

of labor market ition~ indicators of 

inflation pressures and inflation ,pec ation~ 

and readings on financial and international 

development& 

In evaluating the stance of monetary policy, 

policymakers routinely consult prescriptions 

from a variety of policy rul~ which can serve 

15. See oil< Jun< SEP. 11hkh appeared asan addeodum 

10 rile minure<of rhe Jun< 12- 13. 2018. metring of rhe 

FOMC and ~ p= nre<J in an 3 of rhis report 

~- Principal po)'lll(niSon SOMA """rili<s 

- so 

- ro 

- 60 

~ 

_,. 

_, 

- 10 

as useful benchmarks. However. the use and 

interpretation of such prescriptions require, 

among other considerat on~ careful judgments 

about the choice and measurement of the 

inputs to these rules such as estimates of the 

neutral interest rate. which arc highly uncertain 

(see the box ·'Comple.,ities of Monetary 

Policy Rules''). 

The FOMC has continued to implement 

its program to gradually reduce the 

Federal Reserve's balance sheet 

The Comminee has continued to implement 

the balance sheet normalization program 

described in the June2017 Addendum to the 

Policy Normalization Principles and lan~ " 

This program is gradually and predictably 

reducing the Federal Reserre'ssecurities 

holdings by decreasing the reinrestment of the 

principal pa)1nents it receives from s..cocurities 

held in the System Open Market Account. 

Since the initiation of the balance sheet 

normalization program in October of last year, 

such payments hare been reinvested to the 

extent that they exceedod gradually rising caps 

(figure 45). 

16. The addendum,adople<l on June 13.1011, is 

3\•ilablear hups:l/ll"w.f<dt'!'alrese~<.g<>~1moneta~po i()·/ 

flles'FO~ICYoli:yNo )a]izlt1ion.lllllU613.pdf. 

As.:ncy d<bl and mong•~b.lck«< s<rurilics 

R~ 

kC'Itl\~ 

- ~1oathl}~ 

- 10 

- ro 

- 60 

~ 

~1111111 1017 Whl1018 11nuulnm ZOI9 ~, ~ Nore: Rtin\'(;)tmrtll3nd r\'(.!cmpbon amoUIItSof3~'fK1 mOf1pgr lxtd:cd$00urit~art proj«1toosSUtnins inJW'IC 201$.. Thcd;,ti' 

o1cOO l~roustJ IAX\"'lllxr 2019. 

Sot'U"E': F<d.T.II esc~t Bank.ofN~· or~: Fede-ral Rescot Soard staiT~l"'btiruls. 
184 


71718039.eps

M().\EIAAYPOXV~EI'ORT: MYl0t8 37 

Complexities of Monetary Policy Rules 

Overview 

\ \011&1)' polic\' rul<s are mathem.lliCallormuLH 

!Nt INto a pol~ in:.r.s~ r.!lt', such .os tilt r.do<.t 

foods r.>:e, 10 a ,.,.n nu mbe< d och« t<onomic 

,.,ial>loHipic.all) induclu>& tilt dt.'"'"'" d ioil•t""' 

from o:s wgt1 ·~lue•b>&"'"' on <SbmllOoi ,.....ICt ~ack in tilt ((0110111)'. Policy rules can Jl'O' ide helpful 

guidance for policyn13 e~S. lndetcl, since 200l, 

prescriptions from policy rules hm IX'«1 included 

In wfiUen ma~erials that are routinely sent to the 

fcde<.tl Open Market Committ .. IF0.\10. HO'>\t\'tl', 

lnte<preti~tion of the p<escriptions of policy rules 

«<~"'"' c>ttlul j~Jd&moat about the me-t of 

the inputs 10 the rules dOd the impl~aliORS d tilt""'"' 

coo<idotatiOIIS N tilt....., do no1 ul.t into acccunL 

Pel)() rule< c.n moo.pora:e I.e) proac•plts d good 

I1II>MII) poli<\. One by pnnciplt is that ntOIIOiat) 

polo<) silould respond in a preclicublt ""~ to ch.!nses 

in «ooomic concl~ions- A seconclley principle is 

that monet.try policy should be accornmod.lu•~ when 

inO<tion is below the desirro le- 1 and employment 

is ~ow its: m.tximum suSUiinab!c 1('\'tl; (00\'tfStly, 

mooetory policy silould be ftllricti•t "lten the 

opposito holds. A third key principle is""'' 10 Sl.lbilize 

inR.!toon. the policy ra:e should bt acijustocl b)• more 

thon ..,..(or ..... in «SppOiS< 10 ptr'i>ltnl inctt.JStS or 

c!Krt-ininlb:ion. 

Ecooom>S1S ila<-e onol) zed Nil\ -~ policy 

rulK, •n<lucling the "-ell-knol\11 Ta)lor tl9931 rule. 

Otlw< rulei include the •IJalancro "f'P'''Ch. rule, the 

•adjll!led Taylor (1993( rule, the •prict le .. •l• rule, and 

the 'fil11 diffetence· rule If'S"'' 1\l-' These policy rules 

t. f<l1 di!<.,.iorlll'g.lrdi ng prin(lpifs for lilt CooclKI cl 

- poli<yond-~ poliq Nios.I<'OIIoo<dol ec. ...... clthtr.deraiR«M•S)-~018 .,_. ll>li<yi'Mciplfsondf'l_._.lloo<dciC..'""""haplc• 

~ 

··"~'-f"'"""""'pol"'--poli<\­ ...... l. 1111'1A1ol'l19iliiUit""'~""""l."'lor <199!\ ·o-,...,..l'oloc\ xu~t> .. ,. ..... .-~ 

itoc'-'~S.O.Sooll.oblr.....,.,.,.JI.l9 

0«....0..' PI'· t9>-1t<. -n.. b.l~n<«htpp!O>dl M< ... ln.>lyr<d 10 John & T>)lor(l9991, 'A Hi!IQII(,IMII)>Ool """"''Y 1\Jiicy Rules; in john 8. TO) lor, <do MOtWWr Policy Ruh!Chk"": Uni>«silyoiONugoPIC'SSi,pp. Jt~l. The 

ol<ftv<~ T>ylor!l99llniltw"wcll<d10ll".JR~I;clwidor 

'"' folln C. \\Ill;..~ 120001. 'lh<,.l,.,.., for Mor..Ury IIIIi<-, on ,l.,......., 11.._• /<JuiiW/ cl lloMy. Ctt61 ond 

"""""''"· lll""<ftlbe1'. pp.9-Apn<....,.lrult .... """-'ioRdle<tltlol•t9$l\ .,_..,~ 

...... """ POns:.s..l' io -Siobbo ondft.IM. 

mlKt 1M lltret ~ p<incipl~ of good mo~t~UI)' pGiily 

noled e"lier. Each rule t.J~es into .JC<O.Jnt estin13tes 

of how fat the economy~ from achit<ing the Ft<ler•l 

Resen~s clual-m.ndato pi; d ma.'li....., emplom-..nt 

onclprnsubolotl 

fcJul d the fn-e ruiK IIICiude the cfiifmn 

~, ... the rottd unempl0)100ftt that is SIJSUinablt 

in the Ionge< run and therurrtnt ~ment 

rate \the unempiO)ment "'" gipl; the first-diff"""t rule includes the change 10 the unempiO)ment gap 

"ther than its le-~1.' lit old<lition, four of the fi"e rules 

include the difference bC!\\ctn '"'"I inflation and the 

FO.\IC's longet-run oblecti,-ell pe«ent<11 measured 

by the annual change '" the price incle-< f<lr per!Mll 

<~ t>ptndturt<. ()I PC£1. while the prnle\-.1 rule in<bles thew btlween the le\"01 d pnces 

lOeb.· one! the le\-.1 d pn<K that would btob<tn~ 

ii inllalion hod IX'«1 consuot at 2 pe«ent from a 

spocif«<staning)-e••II'IJ~).'Theprn-les-.t rult 

there!>)· uk.s accoun1 of the dt\·iotion d inflation frorn 

lcoounu«i on nex~ p.~ge! 

Pclicr. -''""'"' ~"'~""'""'"""""""byther.de<ol R<l<nt S.nl< ol ~Cil\,lield in iKksonHole. \1\o. 

AiJ&u<ll·l ~CIII:f<d!r•IRtwn•B.InkciKarw a-,""' m-s9. hap\JI••• U....:i!\1td.oo;~ 

,.._l9Mt&l.prlf"""'."""" ................ iolrocb:tdbl""""'-~·lOOl\-.1 

\-lllfic,ANI>·•*""""btulo.'Jovm;l 

.... ,-..,.,,_ ...... so~,pp.98l-tOli.A 

~·""""clpoli<yNitsoonJohn&T"lor 

ondJohnC. 1\JI-•ZOin ~"'!!le•r<IRobuSIRulr-lfor 

MMtt.v)' PolK'\, .. 1n ~mli!IM. fr~n ilnd Mic:h.ltl 

Woodiool,<ds .. fl.lrx/bool.cl.lf()llf!~•lconomia.mi.JB 

(,\mll<<d.lllt NoroMfoiiJr<!l, AI· 8~S9. The,..,. ,,(uMI' 

oltli<HlJ>dbooldM«-.wylcCI>I)tlli(s•lsol•""''' 

-hesooht<tb.anpolic\-rule>fordefflingpclin«l< 

pcescripclon5. 

J. The 11\lor <1991• rvlo..,..,......t!bd: in"""""' 

..oliu:ioo""""' ..... "" ~--""" ...... -lt.tlciiOIIp>!'-~(;I)I'·Md•b.at 

CiOP•ouldbtilf .. «OfOI'I'I \Jo.K~~~ 

tqib-. The NII-I <I f ..... A..,.......,. !bd; in-. 

L<iloubOII~IIIf-..."""'&'P""''ad,b<austN 

~'~'beae<""'""'""ro'IC'•"""""l·sooiiOprornoot 

trWitnumem¢q,tnM. ~\O'.emtnli in t~af:etN:ti\'t 

me.tWresol ft'§OU!Ct ut1l11~tion .1re higl~· corrfia:ed. fol 

mace inform.uion. K't lhe note bebv f~gUre A. 

4. C.lcul.>ling lhe p«!Criptions ol lilt prict-lt\tl rule 

r~i•es setro.ng;) ~111ng )~.U fOt the price lt\-el from whkh 

tocumul>:•the l p««111 ""'"I ioll.ltion. f'S'JreB u«s t998 asthe.,rting\fM.Arour<ltt.oliMf.tht...,....ingll<nd 

oliotWbonond ........... iliJI.tioo~!Uboltml 

". ~t<.t ,..,.,_ ~"' ra ""'' m.c.o. "'"'dost .. 1Jifl""l 
185 


71718040.eps

38 PART2: ,\ION!TAAY 1'0\«:Y 

Monetary Policy Rules (continu<d! 

A. Moneta!)' policy rules 

Taylor (1993) rulo 

Balaoo:d·approoch rule 

Taylor (1993) rule. adjl;ted 

FirsHiiffr:renct rule 

Non;: R. . Rl-'. '~. R/>t, and ~~~ rtprcseot tlx: '"J.liJC'S. ofttM: oominal ffdml funds nne Pf(S('ribcd by the Taylor tl993), 

b313111.'\-d-3J1PCOOC'b. adjust~-d Ta) lor (1993). pri«·lc\\'1, and fifil-diffm'flfX ruks.ttSpX~i~cly. 

R.,cknot~thc- actual nominal f«l"tal fu.ndsra1t:forq1.13n:cr r.tt is four~uarttrprict infhtiott forqU3rttr r. u,i$ tht 

unemploymtnt rateinqoon~ r. and ,,u istJ\colt\'tlofthe ntult.ll real fNI.."nl funds r.ucin t~ longer run thlt on 3\'ttagt. iJ 

c-x~··ud to bcoonsistrnt \\itb :su~1aining ma.\imumnnpk)rmrnt and intbtion at the t!OMC's 2 pcn.<totloogcr-runobj«ti\'t, 

t•. tnadditioo.u}•is ti:K- r:neofunemplo)mtflt in tik lor~~rrun. Z,isthccumulatirc sumofp.Jit dc\i31ioosofth:f~-&:r.tl 

f\ll'lds rate from~~ pl'\'$(Ti~nsofthcT3}1or(l9?3) 1'\11.! \\'hen that n.dc prescrilxsstnin,gtl'K- fcdr..'131 r~,~.nd$ ra.tc-~tow ttto. 

Plgilp,iStht J)el\'tntd.."\iationofthe3C:I.U3l k\<tl o( pricts rrom.a prire lt\·\'ltb.lt rists2 petctnt pt.."'l }'W fromitsltwlina 

S(JM!i<d Sl3ning period. 

The Taylor (1993) rukand'()Li-.'f poli1• I'\IJ..:s are gco..'r.aU) v.'Ti!trn in tmn~ of the dt\iatioo of ml ootpul from its full 

<;'~~city lc\cl. In ~ t<juatic>ns.. the output gap has bctn rtplao.'d ~~oitb L~taP b:twctn tbt rate of t~MIJlpiG)mtnl in tt.t 

loi)$rrun3nd i1$3ttuallc'wi(LI$itlg3 f\"lalioal$}1ip kttO\Io'J\bOl:tln's law) in order to ttprtStt~ttbt ruk$ in rcrmsoflbc 

FO~ C's st3tUt01)·pk Historictlly. nxwcmcnts in the ®tput and un.:mploymcrll gars ha'l' bml high~·oombtcd. Bo..~ 

note 2 pro\».."S rd'crrnm: for •he poli..)' nJb. 

the long·run objl!(til~ in earlier periods as 11~1las 

the currer~t period. Thus, if inll.ltion had beerl running 

peru~erld)• •bol• 2 percer~t, the p<ice-lel'd rule would 

prescribe a high« It'-d for the federal fuoos rate than 

rules that u<e the curr"'t inflation gap. li~ewise, 

if inflation had beerl running pe<>ist..,tly below 

l p<tCer~l, the p<ice-iel-.1 rule would prescribe sefling 

the poli<y rate lower than roles that use the currer~t 

nflation~. 

The ~justed layiO< 11993) rule recogni<es that 

the federal funds rate cannot be reduced materia II)· 

below zero, and that following the prescriptions 

ol the stond.udlayiO< (1993) rule after a reces~on 

during which interest r.tles ha\•e iallen to their lower 

bouoo may. for a time, 001 provide enough poli<y 

accornnlOdation. To make up iOf I he cumulati\-e 

shortiall in a<commodatiO<l I.Z), tilt ~ju~ed rule 

prescribes only a gradu•t return ol the policy rote to 

tilt lpositil'e) lewis prescribed · the st.lndard Taylor 

11993) rule after the economy begins to recO\~r. 

The panicul•r p<ice-le-d rule spe<:iiied in figure A 

also recognizes that the federal funds rate cannot be 

redoced matt<ially below zero. If inflation runs bei0\1' 

the l percent objecti1~ during periods 11i>en the rule 

prescribes sefling the federal funds Idle 11~11 bei0\1' 

1..ero, I he price.lif\-el ru ~ ill, O'l't'f lime, ptO\•ide 

accOillmod,llion to ma~e up iO< the past inilation 

shorti•ll. 

The U.S. economy is con1plex, and the mooetary 

policy rules shown in figure A do 001 capture many 

dements that are relev•ntto the cooduct of monet.lry 

poli<y. MO<<OI'er, as shown in figure B, different 

monetory policy rules often offer quite ifferer~t 

p<esaiptions ior the federal funds rate.' In practice, 

thefe is no unique criterion for fawxing one rule 0\'ff 

ano!her. In recent l~•o;. alnlOSiall oi the policy rules 

(conUnu<d) 

S. These prescriptions"' alcul.!!ed uling !II poblisOOJ 

<bla ior inilation and the unem~-met~t rate and (21 

SI.H\'t) .. based estimates oi tht loogtt·,un \iii!Je of tht nt\ltril rul inle«ii. r.-tc and the !oog«-run \'alue of the u~mentralc. 
186 


71718041.eps

"t' 

MONEIARYI'OUCYREI'ORT: JULYI0t8 39 

2014 l0t6 ))IS 

, ... 

-I 

_, 

_, 

-l 

_, 

-a 

~:t Th:rulo!:s~~'~¢1whr$on.~f<6.'0:1M6$~21'141h:~ltlmll'lC{,~iJt:o.'«<l::t{\j~lb:~p.'tt.~~ia 

lbt~iral."tlkc~~t'\j.\.~(fa)~fi»!XId~.~,~P'oj..'\1:it»SofiMtaa\~lkclbrW:ni~fll(ad 

llx-.~D."'Il!Wxt~-Ntboup~t(tumu:X~'1i.1csfNaaB~""'f.«a..lcaKID&~llx~\-biGilD:ots.bl'(ll 

~~ pcttm. Thc-bl$(lukol6.:fM" lr\"i i&lb:n·.:"'~~p:hdcllh:~iD&'i f\'lrPCE('\~~~a'XI"R ia 199S~•lr:'I'('I,'UP,'f 

)'Qt. 

Sct.JJCI:f~~~e.dolfflt~Wo."..;nK);v.-.,.,Bb:Cbp~~fo$cBJR.N't'l'f:Bo.1nJ.!tlfrat~ 

shown have c.~ lied for riling'"'""" oi the f«letal funds 

role, btr1 the pa<eoi ughtening lhatihe rules prescribe 

has ''aried widel>'· 

Uncertainty about I he neutral interest rate 

in the longer run 

The Taylor (1993), balance<l-app<oach, adju<ted 

Taylor (1993), and po-ice-level rules p<ovide 

p<escriptions for the ~f!l oi the i«letal funds rate; 

all require an <Siimateolthenewal real inlef<SI me in the longet run ~.''l-that is, the level oi the real 

f«letal funds role lhal is ""peeled 10 be consiSien( in 

the longet run, with maximum em~loyment and Sl>ble 

inllarion.' The neutral re~l interest r.are in the longer 

run is deietmine<l b)· wuclural features of the economy 

and is not ob<erloble. In addition, its _.lue may '"'Y Ol'et time becaUle ol flOC1uations in trend productivity 

6. The flrst·cfriietence 1U~ st.cr...n in l"igure A does~ 

require .1n e!Aimatt d.1N! netJtril1re-.al in:ec~ r~e in the ion&e'rtW. HOWt\'tf, this ru1eh.Js itsQfl.\ll sbottcoolint>- for 

~mple. restar<h sugses;s IN11hi:s sort U rufe will result in ye.r.e. ,OOtilit)· in tnlp1oo,'J'netlt ,dnd inii.Jtion rtbti\-e to \\hal 

•ould be obl.Jii'Ofd uncle< Iii< T<yb (199l)and b.l~· 

a~ rules unles the e!fimatesoitheti!Mt;d •tal ~.-1 

funds r.J:ein the !onset run .lndtAer.J:eof uM"mplo•imt'nl in 

!he ~ nm ~t a1e illtluded in those rule$ are wfficiena~· 

i~ from thei1 ltue ~·alues. 

gt01~h. changing demogtaphk>, and 01he< shins in the 

~ruclure ol the economj•. As a resul( estimales oi the 

""'lr.l real interest rdle in the longet run made ioda)• 

may differ sub<!.lnliallj•lrorn estimates m.de late<. 

Academic lludies have <Siimated the Ienger· 

run \'t~lueoi the neut.tJI real inte~est rate using 

Slahllic.!ltechniques 10 capture the '"nations among 

inflation, inlet<SI taleS, real gross donl<Siic produc( 

unem~loymen' and other data series. The tang. oi 

estimates~ ll'ide but suggests that the newal real rate 

has decline<! since the turn oi the """lury tfq;ure 0.' 

Thefe is substantial ~~~stical uncertainty sum)mding 

each es~imale oi the longet-nm \•alue oilhe netJtral 

real rate, as evidence<! by the ll'i()th oi the 95 percent 

(conrinue<l on ,.,XI page! 

1. The"nse""""''""OOilljJW<I"'""puiJI;s~-«~ va~ or \a lues comjXf.ed using the met~· irom lhe foil&,, ing stud~ Marco Ott Negro, Domenico Ci.lnnone, 

•'"" P. Gu-i. and .Wm Tambok>lli llOtll. •SJle<y, 

liqu~<y • ..0 Ole NaMal Ra:e ciln:«"'-' B•ocki'8' 

PapeN on Ccooonlic A<m·il)•, Spring. pp. m-94, "''~""' \\uw..bccd:ings.edu.lwp-<ort;enl.<'~7i081 

dtl"'%'«"1!j)t7bp<aj)di; li.ltlwyn Hoi•Ot>. Thoma<Uubac~ 

.and John C. \\~lli.Jms t201 n, •Me.asuring tile NatiJfal 

Rate oi Interest: lr.::trnatklNI Trends atd lX>cermfnJA·s.: 

/0<#"11 oilnt""'...., CcOI>OIIIi<s. SUW· I, ,'(li. t08 

IMayt, pp. SS<)-75: S..~min K.iolw"""" Jtld nmar 

"'""" ~16!. 'The E>p«W R.,lln;<-"' R.>te in the long Rul'l: T~ Set~ [vidt.>oce with lht Eff«til'f: loo.,·E'f 

Soond.' fl'DS No<es ~\'W>ing:oo; Boofd ol ""'"""" 
187 


71718042.eps

40 PART2: ,\ION!TAAY 1'0\«:Y 

Monetary Policy Rules lcontinwdJ 

unc<rt.lin~· bands lor !he estimated \Oiues in the tlr~ 

quarte< of 10181figure 0). 

The longer-run fl()(mallewl oi the iedefal funds 

rate under appropriate monet.lry poliC)'4'J'IIto 

the sum of the neutrolreal inte<est rate in the longer 

run and the FOMC's 1 peroent inflation objectn..,._is 

one benchmark ior e\'JIUJting l.he current ~ance 

oi n)()fle(ary poli<y. Un<ertainty about the Ionge<· 

run value oi the neutral real interest rate leads to 

unc<rt.linty about how far the current federal funds 

rate is from i~ longer-run 110<maiiMI. For the Taylor 

n 993), balan<ed-app«>ad>., adj~ed Taylor 11993). and 

price-1"'-el rules, different "'imates oi the neutralr<'al 

interest rate in the longer run tr<~nslate one·for·one to 

diffe<enctS in the prescribed setting oi the federal funds 

Idle. As a result !he subst.lntial s~ti~icll un<ertainty 

accompanying ~imates of the neutral rate in the 

longer run implies substantial uncertainty sunounding 

the r•escriptions of each poli<y rule. rollowing the 

p:escriplioM oi a policy rure with an incorrect value oi 

!he neutral rate coold lead to poor economic ootcomes. 

If !he Ionge< -run 10lue oi !he llefJtral real interest rate 

is cunently at !he low end oi !he range oi estimates, 

oi the Ft'dftal1testl\~ S)irtm, ffbc'wlty 9J, https:/An\W. 

ftde<olr""'~¢ec""'eld.>"''"""~<ds"""'<'<l0tr,l 

the-txpect«J_,~.~I-i~eres~-r<~t~tD-(he-long-AA'Hime--sertesf'\idence-with-the-ff!ectr.-e-b"·t!f·bou00.20160109.htmt 

MkhJ~T. KHeyQOtSI, "IW>.liC.nlheO.~T~IVsobovl 

the Equilibrium R:t.al In~ .\ltt?~ finance .and fCOtiOMics 

Discussion Series 2015·77 \Vaslli~on: So.!rd ol Gol."tmM 

of the rm•l Resen~ s1-. Sq><tmbetl, hlrptid<.dot O<Sf10.17016/FEili201l.071: Thom.lsuw.ch and lolln 

C. \\~Ui.lms fl015~. ~Me.awrirll; the Niluf11 Rate of ln1«tsl. 

R~· Hot<hlns C<niE<II'orl:;ngP'l"f IHII'>sh;"&'oet 

8rookiflgslnslr.U1ion.,N'<Yi'ftllbtf),~'WW b«dings.. 

eduA''fXOI<<OO'~ ~1liiii'PIS.ullb>ch·I~IH"""' 

natu~al-inll!feSI.·r.ltt·«'du~.pdi; Kurt r. Lev. is and ffal')(iSOO 

Vazqutz·Crandet20171. 4o\1ea..suringthe N.ll\ltal Ra:eol 

tnter~: Al:emali\-e Speciflcjli()ns.,"' fiMnce and EconomiC$ 

DiS<ussionSetiE's. 2017.059{\V.ashi~oo: Bo.udoi 

C. R:.nge of sri~XItd ~tima!es fot' the- t~n~lral ml rrderal funds 11te in tk lon,g~r run 

- s 

_ , 

-) 

-! 

-I 

-I 

-! 

1\on: llK'sblall:llirs~pmo.h()(~~uikfiMib) 

e.c~~bmc4~~cb. 

$ol;l(1: r~1 Rrtc't\( ~wfl'takll.~alo:oo;•illlrddtl).~ 

lt!ltdilbo.\!Xkl 

then moneta~· policy is more likely to be constrained 

bj·lhe lower bound on nomin.1l inte<est fdtes in the 

future. Hi~ork<llly, the FOMC has cut •he federal 

funds rate by 5 pe<cent.lge poin~. on a-,.-age, dur;ng 

doll'nturn< in !he e<Ofl()(ll)'· Cutting the federal funds 

r.11e by !his much in nesponse 10 a lulure ecooomic 

downtum may no1 be feasible if !he ""'ual federal 

fun<~ rate is as low as most oi !he estimates suggest 

lconunwdJ 

Co--..nors of lhe fm•l Resen• Sr•<m, June>, ht:ps11 

doi.OWI0.170WF(I)S.1011.059; Thom.lsA.Lubil< and 

Cllti~ian M~tth6 (201 >•. "Qkub1tng the NJ:1ur.al Rateoi 

IA:t'l't'Sl: A Comp.J~ oiT\\'OAI~etnari\-t Appc~ .... 

!<ooomic Bri<l 11·\0iRid>mond. Va.: fult<al ~.Ban\ 

of tUcl>mond, Oci<>l>o<), haps;IA'""'·rkhrnondit<!.~-lm<dial 

ri<Nnondiroof&~;oo,i"""'rd.:«oooo>~-bliA>V!Oill 

pdi'eb_IS·IO.pdi. 
188 


71718043.eps

MONEIARYI'OUCYREI'ORT: JULYI018 41 

D. Poin1es1imaoosand uno:nain1y bonds for neuoral real rJtc in the long<r run as of lOIS:Ql 

Stud)' Point CSiim:ue 95 pm.~t ui'!Cfftaint)' band 

Dcl N<gro and othm (2011) 

Holston ond others (20 17) 

Johannsen and Men ens (1016) 

Kil<y(201)) 

l.auboch and Williams(2015) 

l.ewisan<l \'azquez.(;mndc(2017) 

lubi~ an<! Mauh<s(lO I)) 

As a result it may not be ie.~<ible to prcwide the iel-els 

ola<comrnodation !"<SCribed by many polity F\Jles, 

potentially leading to ele\o:ed unemployment and 

infl.1tion il\oeraging below the Comminee's l percen1 

objecti1~ • Rules that t1y to oliset the cumulati1~ 

short/all oi a<comrnoda!ion posed by the lower boond 

on nominal interest rates, such as the adjusted Taylor 

(199}1 rule, 0< make up the cumulalivt short/all in 

the lewl oi p<ices. such as the pric .. Je..~l rule, ace 

inten<led to mitigate the eliec~ of the lower boond 

on the econom)' by P'OI'iding 1110<e acconmlOdation 

than P""ribed by rules that do not hill"e these 

n~keup ieatures.' 

8. for fuMet d&ussion oi these issues, see Mi<Nt.>l T. 

Kilty and 1oM 'l Roben> l20171, ' Moneca'l' ll>l<r in aL~.­

In:fff'!.t R.lte \\'otid.' Brooking> Plf>M on CcMOml(' AcrliiJy. 

Sp<i~ pp. ltl-n ilttpsllh"'w.il<oolings.edu"'JKOOt"" uploj<W20t7100lcii<)~"1J1>tlilj>ta.pdf. 

9. !cooomist< ""'~ fouoo oh.!t a 'mokcup' policy"" bE'thebestr~inthoor)·v.henthepolicyinlerest 

rcl:eisconstr<linedat;:eto.~BMS.Sffnal'lk.et2017J. 

'""100ttat) Policyin.JNev. Er.t•papet~esenled<!t 

1.3 

.6 

.7 

.4 

.I 

1.8 

1.0 

(.i.2.1) 

(·l.U.l) 

(·l.l.2.5) 

(·.6. 1.6) 

(·5.4. ).6) 

(5.3.1) 

(·2J.4.5) 

In the) .. ~ foiJo<,·ing the llnancial crisis, with the 

iederal iunds ra:eclost to ttro, the FOMC recosnized 

lhal il woufd ha\'e limited scope to res.pond to an 

une>pected weakening in the e<O<>om)' b)•lo<"!ting 

short·term inle<est rates. This risk has, in recent)~'"· 

prcwided a sound ratiOMie f01 iollowing a more 

gradwl path oi rate increases than that prescribed b)• 

some policy rules. In lhese circumstooces, increasing 

lhe polity rate quick~· in O<der to ha1·e room to 

cut roltes during an economic downturn could be 

counterprodudive bec.1use it might m.1ke a do\\ ntorn 

more likely to happen. 

·Rethinking t.licroeconomic Policy; .1 conft'ffOCe he$d at the """""'tn$!hute io< lo:..,.tioolt !cooomicl, ll'>lhingl<Cl. 

Oool>t< 12- 13, http</.'J>~ com.~r•e<Miles'documefliSI 

be<n.lnke2017t Oll!"'"'.pdf: aoo Mkh3<1 ll'oodfO<d(t99!1), 

'C..Ill>en~a')' Should "''""ryl\>licy B< Coo<loct<d in.ln fla cl Ptice Slabilil)·~· in Nev.• ChJISMgt?s lot MOOfW)' 

Po/ky. p<Oeeedings cia S)mposium spoosclft'd bj• tl>e r.de"l 

R.,.f\0 Bank of"'""' City (Ka""' City, Mo.: federal R""'e Bank oiKansos City) pp.177-lt6. ilttpsl!h~,w. 

kan$.1SCityf~ica1i~n'SearcM'5Cp.$.~UillY 

t!Cp-t999. 
189 


71718044.eps

42 PART2: ,\ION!TAAY 1'0\«:Y 

In the first quarter, the Open Market Desk 

at the Federal Reserve Bank of New York, 

as directed by the Committee, reinvested 

principal pa)~nents from ;he Federal Reserve's 

holdings of Treasury securities maturing 

during each calendar month in excess of 

$12 billion. The Desk also reinvested in agency 

mortgage-backed securities (M BS) the amount 

of principal payments from the Federal 

Resen·e 's holdings of agency debt and agency 

M BS received during each calendar month in 

excess of SS billion. Over the second quarter. 

payments of principal from maturing Treasury 

securities and from the Federal Reserve's 

holdings of agency debt and agency MBS 1vere 

reinvested tO the extent that they exceeded 

SIS billion and Sl2 billion. respectirely. At 

its meeting in June. the FOMC increased the 

cap for Treasury securities to S24 billion and 

the cap for agency debt and agency MBS 

toSI6 billion, both elfecti,•e in July. The 

Conunittee has indicated that the caps for 

Treasury securities and for agency securities 

will increase to $30 billion and S20 billion per 

month, respectively. in October. These terminal 

caps will remain in place ·until the Committee 

judges that the Federal eset~oe is holding no 

more securities than necessary to implement 

monetary policy efficiently and elfecti1·ely. 

46. F«l<r.ll Re<m'03SS<lS311d liabilili« 

The implementation of the program has 

proceeded smoothly without causing disrupt ire 

price movements in Treasury and MBS 

market& As the caps ha1•e increased gradually 

and predictably, the Federal Resene's total 

assets have started to decrease. from about 

$4.4 trillion last October to about S4.3trillion 

at present, with holdings ofT reasur)' securities 

at appro,,imately S2.4 trillion and holdings 

of agency and agency MBS at approximately 

Sl.7trillion (figure 46). 

The Federal Reserve's implementation of 

monetary policy has continued smoothly 

To implement the FOMC's decisions to raise 

the target range for the federal funds rate in 

March and June of 2018, the Federal Reserve 

increased the rate of interest on e.1cess resen·es 

(IOER) along with the interest rate offered 

on overnight rererse repurchase agreements 

(ON RRPs). Specifically. the Federal Resen-c 

increaS<.>d the IOER rate to 1¥. percent and 

the ON RRP oft'ering rate to I y, percent in 

March. In June, the Federal Resen·e increased 

the IOER rate to 1.95 percent- S basis points 

below the top of the target range-and the 

ON RRP offering rate to IY. percent. In 

addition. the Board of Go1·ernors approved 

m1 l!11l lOIO lOll ZOI2 2013 101~ ZOIS 2016 2017 2'01S 

NQw.*('f\'\Jil:aad~T) f-.~M~(If~.9.\~ a/)lj~((~il;«'f"''Q*J(1jon~C\"'tta)ltW;!iquidir)$'o\-.,:iq,:«<(ct 

Milll.'fl . 8c.arSt.,"'"JJ!'M,.andAIG:ar4«btfet\"Jii f.xil~ incltJdinslh:Primar)• D:UrCrtdit f.lcibl). tb: Mio.1·Bad:cdCOC'WI'ICf~ Papo.'t ~l(6.1 

~ ~IUiual r~ ~~ f~!i~;y. 0: c~ hp:r f\tlding faciliTy. -.1 UJc T;:nn Mct·lbdo.~ ~"l.li iesl,(qn Facitay. ~ asscu~ 

i!>:bht;CWOtti:tcdpr<tfli1,1:1'11Satld~boo~ONI!cldour.rtp..~Widodlcttiabi1iti.::i-eo.:W:s~~~a~'ITII."f'R.'41tU.S. 

Trta.olur)·~,.,.,UAc.."o))..ll,anda.:US. Tl't'~~-mr:1lllf)'Fu*"-...,AC'«!!CL tkdaUit\k"'OihrougbJifly-1..2018, 

Sol.-.«: fcdcft]Rc$cn.:Bo.v.i~lisi~Rd..'t5t i-4J.·f.1d011A~R<$m'tlb~-
190 


71718045.eps

a V. percentage point increase in the discount 

rate (the primary credit rate) in both March 

and June. Yields on a broad set of money 

market instruments moved higher, roughly in 

line with the federal funds rate. in response 

to the FOMCs policy decisions in March 

and June. Usage of the ON RRP facility 

has declined. on net. since the IUm of the 

year, reflecting relatil>ely auractire yields on 

ahernati1·e investments. 

The elfec.tire federal funds rate mo1'ed up 

toward the IOER rate in the months before 

the June FOMC meeting and, therefore, 

MONETARY POLICY REPORT: JULY2018 43 

was trading near the top of the target range. 

At its June meeting, the Commiuee made a 

small technical adjustment in its approach 

to implementing monetary policy by selling 

the IOER rate modestly below the top of the 

target range for the federal funds rate. This 

adjustment resulted in the elfectire federal 

funds rate running closer to the middle of the 

target range since mid-June. In an environment 

of large reserve balances, the IOER rate has 

been an essential policy tool for keeping the 

federal funds rate 11ithin the target range set by 

the FOMC(see the box '"Interest on Reserves 

and Its Importance for Monetary Policy'"). 
191 


71718046.eps

44 PART2: ,\ION!TAAY 1'0\«:Y 

Interest on Reserves and Its Importance for Monetary Policy 

The fin.Jncial crisis that began in 2007 uiggered the 

deepest rece«ioo in the United Sl<!tes since d10 Creal 

~ession. In re>j)(Nlst, the I Optn Markel 

Commillee lfOMO cut iu targe~ ior the fede<al funck 

rate to nea~)' zero by bte Z008. Oth« short-term 

interest rotes declined rooghl)' in line wilh the fede<al 

iunds rate. Addilional monetary ~imulus w"s neces_(,jjry 

to a<!dre« the signifrc.1nt economic downturn and 

lhe .associated downward pressme on inllation. The 

FOMC undertook other nlOOelary policy ad ions to 

put dol' mvard plesS<Jte on looge<·term int""' ldt.,, 

including la~S(.lle purchases oi longe<·term Treasu~· 

securiti" and agency-guaranteed mongage-baded 

securities. 

These polk)' ae1ioos ma.de financial conditions more 

acoommodati1-e and helped spur an f(onomic recm-ery 

that has become a long·lming economic ex,.nsion. 

The unempfor"""t rate has decline<l from 10 percent 

tole« than 4 pere<nt "'"' the course of the rf((JI-ety 

and expansion, and inflation has been !ow and iairly 

Sl.lble. The FOMC's a<:tions """'critical to fostering 

progre« toward m.u<imum ,.mp!ormentand stable 

pric~he Sl<llutOI)' soals ior the conduct of rl10f'oelary 

polic)' est.lbli>hed b)• the Congress. 

The FOO..al Reserve'> latge-scale a«el purchases 

had the side efff(t of generating a ~,.ble increase in 

the supply oi """~ balaoces, ~~~ich are the balances 

that banks main!41in in their accounts at the Fedet'al 

ResM-e.' From lhe onse1 of the financial ctisis in 

August 1007 until October 1014, ~~~ the FOMC 

ended the last oi i~ OS>elfJCJr<hase progroms,the 

supply of rest<\'t h.!Llnces rose from about SIS billion 

to about S2V: trillion.' R.,..~~ balances rose ~~~11 

abol-e the l01-el necessary to meet resen~ requiren10nu, 

th<SS ~~·elling the quantity ol ox cess rest<\~ held b)' the 

banking I)'Siem. 

1. All depo>itorr irnti!urioo> (((Witrnef<i411wlks,$3\ings 

banks, tlwih i~iMioM, crtdil uRioM, aOO most U.S. OOochts 

ar.d...,.il'sottore<snoonks)that""i""'inr""'•"''.li>CtS .Jre el~ 10 wn interest (ll'ltnose ba~nces. \\'e reiet-10 

theseinstitutioosAS•banli,: 

2. for adtttiledcfisc:ussioo olOO.vthe<hantr-infeder,d R"'"" l«Urilie> hofd;~ •fi<ct tJ>t f<der•l Re~et~t's babocesheetand«<ttr;oltlwU """""l);""~n< 

I!Kig, l.aw""'eMize, and Grett.l<nC. Wrinb.Kht!Otn, 

•Hf>vlloestl>e FOOAdi"" 11$ Sr!<OOtil's Hol<li~ ar.dl11>ols Aff«ted?" finaoce .1100 f<Onomics DOCussioo SeriE-s 2017· 

099~V..,irrgton: llo.Jrd oiC..'"""'olllle f<deral R"'"' S)'Sttm, Sep!Mlbeft. httpS.:JAw.w iedet<~f«>sMt p.·reconrtY 

f....Mit.YIOIIO<J'lt»p.pdf. 

As the economic oxp.1nsioo continued and 

unemployment declined-.Jnd with labor markei 

coodilions projected 10 continue impt0\1ing-the 

FO.I\C de<i<Jed !hat it would scale bad policy 

support by increa>ing the l01·el oi short-term int"est 

rates and b)• reducing the federal Re5el\·e·s securoies 

holdings. To th.lt end, the Comminee began gr.1dually 

r(lising its urget r~nge for the fedefJl funds •ate in 

December 101S.late<, in October 1017, il began 

gradual!)' reducing holdingsoiTreasury and agencl' 

securities; this gradual teduction rt»SU!ts in a decline in 

lhe supply oi rest<\oe balallCf>. The FQ.I1C judged that 

removing monetary policy >timulus throogh this mix of 

fir>t rai>ing the federal funds rate and then beginning 

to shrink the baJcmce sheet would best conttibute 10 

achi~·ing and maintaining maximum emplo)•ment and 

price stabilit)• without causing di~loc:~tioos in financial 

matke~s or inslitutions that could put the economic 

expansion <~I risk. 

Interest on resen'eS_.he payment of interesl on 

balances held by banks in their accoun~atthe FOO..al 

Rese~~ l,..n an e«enlial policy tool that has 

permiHed the FQ,\IC to achiM a glddual increase in 

the fede<al fund> rate in combination ~~th a &lddual 

reduclion in the fed's securities ho!ding.s and in the 

suppl)' of resen't balances.• ln!er~ on resenoes is a 

tn011e1ary policy tool used br all oi the 11orld's ""'jor 

central banks. 

lnlerest on reserves is the principal tool the FOMC 

uses to anchor the fede<al funds rate in the target range. 

The fede<al funds rate, in turn, e>tabli>hes an important 

benchmark for the horrm1ing and lending deci;ions 

in the banking sector (figure A). When the federal 

ese~~ increaststhe large~ range for the fede<al funds 

rate and the in:erest rate it 1"1' on rosen• balAnces, 

banks bid up the rates in shon-t"m funding ""'rl:ets 

10 le.,.els consi~ent with those increases; ra1es in Olher 

short-te<m funding markel>-00 as oommercial 

paper rates, Treosury bill rates, and rates on repurchose 

fconUnuedl 

).lheFinanc~ISe<v~esRosuto:oryReli«Aclof2(1()(, 

.t!Ahotil!ed d~ feckfal Resent &lrtl:s l<l M' iM~es~ on ba\Jnces 1-.1<1 by or oo bellaN ol depoOt~· ;ll!liMioos ~ 

federal R""'t Bani$. wbj«t 10 regu\Jtioos olthe llo.lrdol 

Gol""""'.effe<t,~Ocrober 1.1011. Theffi«ti\•da:eolthis 

'"hori~· .. sch.ulged to October 1,1006, by tile E""'S"l'Y Economic l{ollil;,.tioo Act oll008.lhe Congress •'-""riled 1~ p.lyment cJ inttft>SI oo rt'Stf\~ to he:p minitnite the i"'enli-1-es for c:ostty restn-e 1\oidar-.ce schemes and 1<1 PfO'ide 

tl>t f«k<al Rtsm• with • pol<y tool rhat could be usdul io< """""'Y polK)• i~,.,,~;oo more broodly. 
192 


71718047.eps

MONEIARYI'OUCYREI'ORT: JULYI018 45 

~~~---------------------=~~~~ ~~~---------------------~~ · 

- !SI) 1~~ - L'O 

- . l011 201$ 

·: nw~ ((lht-brf-~~ ii: tht t'll <o rt$«\c:;;.Dit 

dJtD: U. illltaflao • b.X'bilu SMisp.'tGl$hipr. Th: kd:nl flllds ~E'«\\oobrrxtsrloJc-l)'cnctoatwc!x'l.o\ttlb(~W.11.0Cfis 

G.....niCollt.ml f'~JUDX. 

Sou:o: F«TfC1;S;t)GCftcp>.DT((~I.l.C'. ~lb<oflb: 

~10t) TN$1~(.lurina:C~f«fcltt.tlfu:t.h.Fcdml~t 

Sri:of~YM.-: bfx.c'1.'4Jib.Bb.la:lh1 f«ilmn4«1~'tSao! 

~~~.r~R~'C'BcG.'\1. 

agt.......,IS-all tend to 100\" higher as well lfigure 8). 

This ill(rease in lhe gtne<OIIe-~1 of sho<t·term Idles. 

togelhe< with the expea.ed future l"th ol sholt·tetm 

Idles, !hen intluen<es the 1.\-el of olhet tinall(~l asset 

p•kes and 0\'etallfinancial conditions in the economy. 

Thu;, changing the inte<oest rate on resents has prOI'etl 

to be an eifec1ivetool fO< ~ansmil1ing changes in the 

FOMC's t.lrg.'l ldnge fO< the fede<al fund< rate to 01her 

inter~ rJtes in the economy. 

The rate ol interest the Fede<al Resen• pays on 

banks' resen•e balall(es is iar I0\1'et than the rate that 

banks c~o earn on alternative safe assets, including 

most U.S. g&.'ffnmem Of agency securities, municipal 

securities, and loans to b~ nesses .and COO'SumetS.~ 

Indeed, the b.tnk prime ratHhe base rate that banks 

use lor loans to man)' of their cus.t()lllefS-is current!)' 

around 300 bas~ poin~ abol" the le--el of interest on 

resen'eS. Banks continue to find lending attt<~cti\'e$ 

and bank lending 11.1s been expanding at a solid pace 

since 2012. Households hal'e begun to see interest 

rates on relail deposics rising as well. MOI'OO'I.W,Ihe 

configuration oi interest rates im1>lits that the return 

the f«letal Resen.., earns on its holdings ol securities 

~. The (oogr<ss'> autlloriz~ioo alk'"' tlte fed« a I R~e IOPJ)' intE«'SSondrposits rNintaiN!d by~Clr)' 

insliMions at a rate not 10 cxct>OO I he ... gtnerAIIe\tl oi ~·tfflll interesl r.Jtts..•lhe reclfnl Resm-e Boofd's 

- . lOIO lOll lOIS 

Sm: 'Tht~l\).:l)dof6:"'-...-ot i:li~~«<~'($n:l.: 

rdll~l3.101talltn,!lidoit~Sbl11:1poilltl:bipKf. 

Scutt: f« US. TrM:I)' toil. ~ {'{ Chc Ttta9.1). kc AA 

(moriala.D.'fNIA"o'f.IDfnt)t on ~n..-.i ~ · fNml 

R=•Bori 

is highe< than the interest il pays on rese~.., balances. 

Each )'eor,the FOOetal Rosen-e remil> i1> earning>-

that is, i~ income net of expenses-to the Treaw~· 

Department in 2017, remiii.Jil(e51()1.tied more than 

SBO billion. 

Had the fede<•l Resen" not been ;ble to pa)' 

interest on resen'e balances Cll the same time that 

excess resM-es in lhe banking system wete large, it 

11oold n01 ""'"been able to gradually raise the fede<al 

iunck rate ando;hef short-term int~eu rates while 

"""'" balall(es were abundant the F0.\1C 1100ld 

"'"" had to take a different 3J>proach 10 scaling back 

monel-try polic)' acconmtO<idtion. This approach likely 

11oold ha1-e inl<>l~td a rapid and sizable redue1ion 

in the r.deral Resen-e's securities holding< in order 

10 put sufficient upwt~rd preswre on intetest rates. 

(continued on neKI page! 

ll<$ulatioo0d«1noss!Joo1{...,,int('r<$1r•tesfo<ihe(lllrposes 

oi th~ authotify M '""rdtts on oblig,llions. \\ilh m.uurities ci no mote than one }'E'.11, soch ~ lhe pim.Jry ctt'dil tillle .1nd 

ra:es onte<mf«tE<aliU!Idl.t«<nrepu<Chale•~. 

COOVI~i.ll pdpf't letm Eurodolbr deposas. And other simil.a.~ 

instrumeats ... The r~te oi intef('St on resm't'S has betnv.-ell 

1\~hin .1 ra~oi $1'1oc't-leftn itltetesl M!es.<'sdtt'it!edin BoJ«f 1egutatioos. for cutfffit wes oo i number ot shoo~enn mont)' 

JNrltt i~ruments.. see BNrd oi C.O..'tri'IOfS of lhe Ft"der~l 

Resm• S)"""· St.lt;,i<.tl Rolt..,.H.IS, 'Sel«t<d In""" btes,"' \\\m ft>def.llrestn."t.goo.·!rele.JSeSih1 ~1ctmt'fl{. 
193 


71718048.eps

46 PART2: ,\ION!TAAY 1'0\«:Y 

lntere.st on Reserves (c(Jftlinuedi 

~ing the pace of as>e~!al" just right for a<hieving 

the fe<teral Rt!lef\~·, objeaives would have been 

e.u ..... ty challenging. Such an apptoach to rerno,;ng 

accommodation would ha'-e run the risk of disrupling 

financial markds, with '"'""" eliec~ on the eoooomy. Indeed, as obsen'ed during the early summer of 

2013, markd reactions to<hanges in the outlool: for 

the fe<teral R...,..~·s holdings of long·tMn securities 

<an h,..,. oul>ized elfoos in bond marke~. At that time, 

F0~1C communications lhat pointed to !he e\'entual 

cessalion oi asset purchases seemed to alarm n~tstors 

and 1<p011edly contributed to a rise in longef-le<m rates 

of ISO basi> points ove< just a fe.v months. Thar rise in 

rates quickly pu>hed up the cost of rnoc1gage cre<fit and 

rates oo other forms of borrowing tor households and 

OO.ines>e>. 

Thus, Fede<al Rt!lef\~ policymake<s judged tha< 

thebe>! >Ualeg)' tor arf)usting the >lanceoi mondary 

policy "oold be grad11<1l inmases in the l<lrget range 

tor the iede<al funds rate, supplement«! late< on ill• 

gradual r«iuctions in the federal Resene's >e<Urities 

holding$. The ongoing. gradual r«<uction in the fe<teral 

Rt!lef\'O's securities holdings that the fOMC set in 

motion in 2017 will bring the level of Jeser\'0 balances 

down subst.lntiall)' OI'Ofthe next fe\V)'Oars. The ~ze 

of rt!lef\-es that banks 0\-entu.llly want to hold will 

ret1ect balances held to me<?l resen'O requiremen~ and 

pa)'n>en~ ~as "~II as balances held to address 

regul•tory and swctural c~anges in the banking system 

since lhe fin<~.ndal aisi5.> A[though the le\'CI of r(.>$ef\1!' 

balances that banks will e.-entually want to hold is not 

S. fO< ad"'"''"" ol the chang<> in tl>e bon~ns >)stem sillre IDe iinanci.'!l crisis .and !heir poc~lillf eii«ts oo the o.m.nd lor r""'• ba~nc., ,.. Ra~l K. ~,., 120181, 

·tiquidil)· Rogulatioo •11<1 Ill< Si;e olthe !<d's 8abnce~~>e«: 

spe«h delio.'tfed •I "(urrtrKits, C~o~t .md<:tnlr.JI B.ank 

8a~"'"' A l\)l;cy Conference:-"''"'""""" S..nford Un • .,,;~l SW>fo<d, C.M, M•y 4,1\ttpsi.lmwl<dcral..-e. goo,Jnewse\~'s.peech.'quarft520 180SOb.hlm. 

yetknOI\0, thatlt~fl is likely to be much 101,-er than il 

i> today, though ;ppreci;bly high« than it was before 

the crisi> ' In addition, the amount of U.S. currencyfe<teral Rt!lef\-e notes--dl.11 people in the United Sl<ltes 

and else\\ here want to hold ha> incteosed substantial~· 

sin<:e the crisis.li ban~ wJnt to hold more resen-e 

balances and the public"""~ to hold more U.S. 

currency than before lhecri<is, the fe<teral Rt!lef\e will 

ne«i to >upply I he rese<Ves and currency, so lhe fe<teral 

Resen'e's securities holdings also will ha\-eto be larger 

than before the financial crisis.' 

Interest on reset\'es will remain an important f>Oiicy 

tool for keeping the i«<eral iunds ,.te within the l<l<gtl 

rang< set ill' the FOMC and thus managing thel.-.-el of 

short-renn interest rare-s, e\'M as the ongoing reduc1ion 

in the Fe<leral Rt!lef\-e'> securitie> holdings g<neratesa 

gr;dual decline in the amount of resel\-e ba~nces on 

which the fe<ter•l Resen•e MS inlenest. In June 2018, 

the fe<teral Resene m.1de a smalltechni<al adjustment 

to de-link the Idle of in:ere>t oo ,.,.,..., irom the top 

of the Committee's l<lrgel range for the iede<al full(~ 

ldtf. At the June 1018 FOMC meeting. the Committee 

increased the fede<al funds l<lrg<l range by 15 b<si• 

points1 wflile the rate of intef~ on resM-e OOiances 

was increosed by 10 basis poin~. Thi• change is 

inlended to enwre th.ltthe federal iunds rate continues 

to trade well within the Comminte's t11rget range. The 

spread beM.,.n the effecti,•e fede<al funds rate and the 

rate oi in1erest on reserves could continue to narrQ\Y 

OI'Oftime as the Federal Resen-e's securitie> holding> 

and the supply of resen'e balances graduall)• decline. 

6. Unc..UOl(yal>outthe"'""'"''"-flolr""'tbo~nces 

i< """"" r"~tlh.it the fO.\lC II.!< boer> rt'dvcmg the r<dor,IR«<n•>holrl~olseo.~i<s.andtheoupplyol 

"""'' ..,~.,. gr"""ltr 7. Currencygrowsrooghfyin ltoewithoominal gross 

ic prodocl, In Oectmber 1003. currtney in <ircukltion 

was around S3i0 billioo. COfi"'P<''~ wiU't S 1.6 ttillion At lhe rodol)me2018. 
194 


71718049.eps

47 

PART 3 

SUMMARY OF ECONOMIC PROJEOIONS 

The following materia{ appeared as an addendum to the minutes of the June 12-13, 2018, 

meeting of the Federal Open Market Committee. 

In conjunction 11ith the Federal Open 

Market Commiuee (FOMq meeting held 

on June 12-13,2018. meeting participants 

submiued their projections of the most likely 

outcomes for real gross domestic product 

(GDP) growth.the unemployment rate, and 

inflation for each year from 2018to 2020 

and O\'er the longer nm." Each participant's 

projections were based on information 

available at the time of the meeting. together 

with his or her assessment of appropriate 

monetary policy- including a path lor the 

federal funds rate and its longer-run \'lliueand assumptions about other factors likely 

to affect economic outcomes. The longerrun projections represent each participam's 

assessmem of the value to which each variable 

would be expected to con\'erge. over time. 

under appropriate monetary policy and in the 

absence of further shocks to the economy." 

"Appropriate monetary policy" is defined as 

the future path of policy that each participant 

deems most likely to foster outcomes for 

economic acti\'ity and inftation that best 

satisfy his or her individual interpretation of 

the statutory mandate to promote ma.ximum 

employment and price stability. 

All participants who submiued longer-run 

projections expected that, in 2018. real GOP 

would expand at a pace exceeding their 

individual estimates of the longer-run gro111h 

rate of real GOP. Participants generally saw 

real GOP growth moderating somewhat in 

each of the following two years but remaining 

above their estimates of the longer-run rate. 

17. 1lm.-e-meml>ersofthc BoardofGO'\nnors"wt in 

offi« at the tim< of the Juno 201$ meeting. 

t8. On< panicipant <lid llOt .ubmit tonser-run proje<1io"' for real GOPgroll'th. theu"""piO)~><nt rate. 

or the ftdml full<ls r.u~ 

All participanls who submitted longer-run 

projections expected thai. throughoullhe 

projection period, the unemployment rate 

would run below their estimales of i1s longerrun level. All participants projected that 

inflation. as measured by the four-quarter 

percentage change in the price index for 

personal consumption expenditures (PCE), 

would run at or slightly above the Committee's 

2 percem objecti\'e by the end of 2018 and 

remain roughly ftat through 2020. Compared 

with the Summary of Economic Projections 

(SEP) from March, most participants slightly 

marked up their projections of real GOP 

growth in 2018 and somewhat lowered their 

projections for the unemployment rate from 

2018through 2020: participants indicaled 

that these revisions reflected. in large part, 

strength in incoming data. A large majority of 

participants made slight upward adjustments 

to their projections of inflation in 2018. 

Table I and figure I provide summary statistics 

for the projections. 

As shown in figure 2. participants generally 

continued to expect that the evolution of 

the economy relati\'e to their objecti"es 

of maximum employment and 2 percent 

inflation would likely warrant further gradual 

increases in the federal funds rate. The central 

tendencies of participants' projections of the 

federal funds rate for both 2018 and 2019 

were roughly unchanged. but the medians 

for both years were 2S basis points higher 

relative to March_ Nearly all participants who 

submitted longer-run projections expected 

that, during part of the projection period, 

e\·olving economic conditions would make it 

appropriate for the federal funds rate to mo\'e 

somewhat above their eslimates of its longerrun le,-el. 
195 


71718050.eps

48 PARTJ: SU \~RY Of ECONO~I C PROitCTIO:<S 

Table I. Eoonomk proj«tions of Feder.!l R"""' Board m<mborsa!ld ederal ~"' llan~ presid<n" 

u!lderthcir in hid ~ assessments of proj«lro appropriate moneta!)' policy. June lOIS 

""'"" \'.uiabk 

~i rdi OP .... . 

;\bl\'b~j:t."4ioo ... . 

:o..~mcol~---·· 

:\11n,:b~"''tioo ..... . 

PC£-....... .. t~:b~ioo ..... . 

CmPCEinllMioo1 .••• 

a~iiiE"o>}:\1.~ ....•. 

\lt!JI0:~'\.1.1.-d 

·~ i'"'. (U!ll 

ill IS 

u 

ll 

u 

).$ 

u 

1.9 

2.0 

" 

l S J.(d.1 .UlS >.H! ll3..8 

)~ lH! J..4J.7 J.6.-t0 -~.l l 

ll 2.0! 1 1.0 !J Z.O!J U•li 

2.0 1.820 !OU 1.8!.1 1_92.) 

ll 1.910 lOU Ull !0 ll ll U.l.O lOU U !.l 1.92.3 

~~(~~ ....... l oi 3.1 u !.9 2.1 ! ~ l~ M 11 3~ !.S....).O U !.6 1.9 3.6 1.9-4.1 lJ l.S 

MatiOhE"0,.'\"410e.... ll 2.9 ,l,.l !.9 Z.l !.- .U ).~ U 1/J !.S ).0 1.~!.6 1.6 .l.9 I!J 9 !.) J.$ 

Sqh:~-..-.fl~ raiPJ~~ GDf'lae.l~""~~PI~m~~rl\W~"-t!!quMottllri'""'._)GI""> 

tllrb:t!kqu~«<ltM)GII'.tneatfC£~-'"" K'l..._a.::l:k~rlk!.dcbttil.~:tiul).lh£roor~'~~~C\.~~ 

lfCa:MtJUor:-~~""'l'((~ko.'IJ,;aJ<O:I'f).Pr.~~lk~*CirMa.-(""lbc~CI'.._~_.r~ lkkw111i'\"Wf~~)l'*l 

~~r.,..,..,..·~~l>'i:~OIIb#otbrf~((~~P*).l.OIIfll'«a~~adlip...~·~~t:(~nk 

L> .... iiUr."ii ~ ........ ~~'\CISLq~CII5tr~~p:o;s.'!ao,i 'l)r~o((~~-\)IQrJx~~~ "'i,hcf.odcfa!fI'JW~Jllt *('itk~cfC)(!"-,o;W~Uip:lflfll(~ik~fOOribfa6:C'I(k~~WJ'CCIMi""'6tWmafdf.nk **cftilt 

~~P"«cwrlk•ra Th: \l~~1)(0-.c"clli&a~1io.-. .. i:JI6c-a.cft~tcr~~:\bM:c-.iiiiii'IIC' Im~I.:O!ItC);:I( 

~41da..'4~ ...... .,."..,_,"tM.W:t....tX~•mi(;Df'.thc:~'IWII'*.«IX~alf..,.r*•~•Otb:!Wdi:O,!I :xl l~d 

*~~11«*-il.:olt.irlf'('<l), ,. ... ~ .. iloekho:'lt l~iml~ 

lforadl~lko."dulla~IW4k~•kt0t~a.:'~f:«a~IO~'Abcltlk~«~~&f\o\'IIL!k0o.\lo»8e.tao~ol 

lkcwoDW!c~1Jo.lW. 

lTh:""*'*ll~~lbi:lk.:t ....... M4~a..-..~'Ut.'ttibfdi~ '*")CW 

J.lb:rlllfl'l"'ll~il a~)nf~ SW'I~-"'·"tio:e.6 .... ~1011is.\N,b'~NI•w~:W•tl!Dt)GI' 

4 I«!Pf.,.."""'1icG!;I«norcl'([.a.o.:.*K.ocn&.~.N. 

In general, participanlscontinued 10 view 

the uncenainty attached 10 their economic 

projections as broadly similar 10 1he 

average of I he past 20 years. As in March. 

most participants judged the risks around 

their projections for real GDP growl h. the 

unemployment me. and infla1ion 10 be 

broadly balanced. 

The Outlook for EcQnomic Activity 

The median of participants· projec.tions for 

thegrowlh rate of real GOP, conditional on 

1heir individual assessmemts of appropriate 

monelary policy. was 2.8 percent for I his year 

and 2.4 percent for next )'ear. The median 

was 2.0 percenl for 2020, a touch above the 

median projec1ion of longer· run gro"1h. Mosl 

participanls continued 10 cite fiscal policy as 

a driver of strong economic aclivity over I he 

nexl couple of years. Many panicipants also 

memioned accommodati,·e mone1ary policy 

and financial conditions, strenglh in the global 

outlook, cominued momentum in 1he labor 

market. or positive readings on business and 

consumer sentiment as imponanl factors 

shaping lhe economic oullook. Compared "i1h 

the March SEP, I he median of participanls· 

projeclions for I he rale of real GOP gr0111h 

was 0.1 percenlage poinl higher for 1his year 

and unchanged for the next 1wo years. 

Almosl all parlicipams ex peeled the 

unemployment rate to decline somewhat 

further Ol'er the projection period. The 

median of parlicipants' projec1ions for the 

unemployment rate was 3.6 percent for 1he 

final quaner of this year and 35 percenl 

for 1he final quarters of 2019 and 2020. The 

median of participants' eslimates of lhe 

longer-run unemployment rate was unchanged 

at 4.5 percent 
196 


71718051.eps

MONEIARYI'OUCYREI'ORT: JULYI018 49 

figure I. Medians. «nt ral tendencks. and ranges of «<nomic ro~ ions. 201 S-20 and mn the longer run 

"""' 

Cll3ngcinf<a!GOP 

- aiwt(l(~o,.,~ 

CCt~tnlsc.J...,.,")(!(p'*'-'ti."CCS 

~«'".;.-

~ 

~ 

-) 

w ~ 

c:c -l 

~ 

-1 

W13 lOI~ lOIS 1016 lOll lOIS 1019 lOlO Lon!'• 

run 

"""" Unrnl~tl'k."n11'3tc 

~ - 7 

-6 

-l 

~ -' """" ~ ~ -) 

!013 1014 lOIS lOI! lOll lOIS 1019 lOlO lon!l'~ 

""' """' PCEi:nlhtion 

-) 

== ~ §§ - l 

~ - 1 

2013 1014 lOIS l016 lOll llliS 1019 llllO Lon!'• 

run 

"""' C~PCEi:nftation 

-) 

== ~ 

iiiii 9§ -l 

- I 

l'OI3 l\)14 lOIS l016 1017 lOIS l019 llllO Lons-,-r 

""' 

1\'on~ D.:finitioi1So \'lrill.llbandotllcr phn.tlioos:a.re n the notcslola.bk l.Tkdltaforlbcartual,'Jll).."$o( 

tl'.:- \'3~:llt 3Mwl. 
197 


71718052.eps

50 PARTJ: SUM\~RYOf ECONO~I C PROitCTIO:<S 

Figure 2. FOMC partkip.1nts' assessments of appropriate m0Jl(l31)' polky: Midpoint of target range or ta~t lew! forohef«kralfundsrate 

-------------------.,..---------l.O 

.............................................................................. ~ .............................. ,,,_ ,j 

···---- -----i''''''''''' '''''''''' '''''''''''-

----------------....:.• ...;• __ __.. _______ <.0 

. . . . . .•••••••••••••.••••••••.••••••••••••••••••••••••••••••••.•••.••••••••••••••.• , .•••.•••••••••• , ••.••••.•••••••• ••••••••.••• ,.,_ J..S 

............................... • • ..... • .... ..................... • ••• .... . ......................... , .. _ __________ ...;....:....; ~-----~-----~--+-----~ ' ... . ................ , .. _ ••••••• • ---···· ····-J .. • ········• ···············- 2.5 

........................................ .................................................... 1 .............................. -

••••• ----- ---------------~------- 1.0 

-··········· ...................................................................................................................... ,,,_ 

l.l 

_,,,,, .............................................................................................. 1"'''''''"''"'''"''''''''"'''-

----------------------T-------- •.• 

········- O.l 

----------------------------- 0.0 

1018 10t9 l..otl£1-'ftun 

Noll: E3dl shado..-d rin:k iodM:.l!cs. tbl \;tli.X (rovDCkJ tot~ rK'3rcs.!IIS IX'n.'tnl~ point) o( a.n indi\id~ ['Jf1i.ip;1n1$ 

jud$fl'ltR1 of I~ mKipoinl of ttbt appropriatr 13~1 r3Jl~ for I~ ftdtt31 i'und$1'tllt'Ot tb.:- 3J'IIKOPri31e tatg-.'t il,'!l\'1 for Ilk' fedtra/ 

fund~ t.ttr: a1 tbr tnd of ttK-S"().'-iiW c-JIMdar ynr or O'o'tf I be long« run. On<: pilrticipant did not submit k>tl~'l.."f·nll'l proj(\1k>ns 

for ol<fol:Ql fvndsral< 

Figure'S J.A and 3.8 show the distributions of 

participants" projections lor real GDP growth 

and the unemployment rate from 2018to 2020 

and over the longer run. The distribution of 

indil'idual projections for real GOP growth 

this year shifted up noticeably from that in the 

March SEP. By comrast, the distributions of 

projected real GDP growlh in 2019 and 2020 

and over the longer run were linlechanged. 

The distributions of individual projections for 

the unemployment rate in 2018to 2020 

shifted down relative to t~e distributions 

in March, while the downward shift in the 

distribution of longer-run projections was 

wry modest. 

The Outlook for Inflation 

The medians of participants' projections for 

total and core PCE price inflation in 2018 were 

2.1 percent and 2.0 percem, respectil'ely, and 

the median for each measure was 2.1 percent 

in 2019 and 2020. Compared with the March 

SEP. the medians of participants' projections 

for total PCE price inflation for this year and 

next were revised up slightly. Some participants 

pointed to incoming data on energy prices 

as a reason for their upward l"e\1sions. The 

median of participants· forecaSts for core PCE 

price in6ation was up a touch for this year and 

unchanged for subsequent years. 
198 


71718053.eps

Figures 3.C and 3.D provide information on 

the distributions of participants' vie11~ about 

the outlook for inHati()n. The distributions 

of both total and core PCE price inflation 

for 2018 shilied to the right relative to the 

distributions in Ma~th. The distributions of 

projected inflation in 2.019, 2020. and over 

the longer run were roughly unchanged. 

Participants generally expected each measure 

to be at or slightly abo1•c 2 pe~tent in 

2019 and 2020. 

Appropriate Mo11etary Policy 

Figure 3.E provides the distribution of 

participants'judgments regarding the 

appropriate target- or midpoint of the target 

range-for the federal funds rate at the end 

of each year from 2018 to 2020 and om the 

longer run. The distributions of projected 

policy rates through 2020 shifted modestly 

higher, consistent with the re1•isions to 

participants' projections of real GOP gro111h. 

the unemployment rate, and inflation. As 

in their Ma~th projections, a large majority 

of participants anticipated that evolving 

economic conditions wotlld likely warrant 

the equivalent of a total of either three or 

four increases of 25 basis points in the target 

range for the federal funds rate orer 2018. 

There was a slight reduction in the dispersion 

of participants'views, "ith no participant 

regarding the appropriate target at the end of 

the year to be below 1.:88 pe~tent. For each 

subsequent year, the dispersion of participants' 

year -end projections was somewhat smaller 

than that in the March. SEP. 

The medians of participants' projections 

of the federal funds rate rose gradually to 

2.4 pe~tent at the end of this year. 3.1 percent 

at the end of 2019, and 3.4 pe~tent at the end 

of 2020. The median of participants' longerrun estimates, at 2.9 pe~tent. was unchanged 

relatil~ to the March SEP. 

In discussing their projection~ many 

participants continued to express the view 

that the appropriate trajectory of the federal 

MONEIARYI'OLICYREI'ORT: tULYIOIS 51 

funds rate over the next few years would 

likely im•olve gradual increases. This view 

was predicated on several fa"ors. induding a 

judgment that a gradual p.1th of policy firming 

likely would appropriately l>alance the risks 

associated with, among other con id ration~ 

the possibilities that U.S. fiscal policy could 

have larger or more persistent positi1-e elfocts 

on real acti1•ity and that shifts in trade policy 

or de1-elopments abroad could weigh on 

the ~pansioo. As always. the appropriate 

path of the federal funds rate would depend 

on el'olving economic conditions and their 

implications for participants' economic 

outlooks and assessments of rish 

Uncertai11ty and Risks 

In assessing the path for the federal funds rate 

that, in their view, is likely to be appropriate. 

FOMC participants take actOunt of the range 

of possible economic outcomes, the likelihood 

of those outcomes, and the potential benefits 

and costs should they oo:ur. As a reference, 

table 2 provides measures of forecast 

uncertainty. based on the forecast errors of 

l'arious pril'atc and gol'ernment forecasts 

over the past 20 years. for real GDP growth. 

the empiO)~ nt rate, and total PCE price 

inflation. Those measures are represented 

Table: 1. A\trage hi:>torical proj«tion error ranges 

~"1'1~~ 

\'Wbk :IllS ))19 i))ll) 

a...,;.~"" Gt>r .... H) !lO ~1 1 

UQo.~l'lle'QC!lt:' ... .o.• !1.2 !I.S 

iOIIIIOO(NIITXfrft,"tS1 •• 1~1 !1.0 .ti.O 

~·tHCilllitl'ltft':ilral.CS~. .0.1 !1.0 ;u 

~r.~R=#' .. '~M't~b,.,.ft-~I\"'OICO;II!<F"~ 

Gf«{J(~,1io;e,~lm;~;ot1tllll-tllbdilotl..:--~\)f' 

-~1k....,~--.rtii"'U>I.""A•ibcfik.dit.O.:M·f~~ "'-.:t• 

u.e~·.,.,.etn.r.~tktta~~~~~Wtl~ 

~.b~GDf'.~'O.'M.....--,'1~.ao41ixWtt.11'-'* 

~ilh:-ll~~~*""'•jq(«~motiMk••lltJ'. 

ru-~~«INo-.jJPd~USPMJ.r.,(~i)."''nPP: 

l.brL~cfOoc~Od.'dl .... l~t;."nt..,:.q~~ 

r~~osn ··~'l.-r~.-ldf~~S..~lil1«\l 

{'llo~h;J(i(..olcrr~tJndiX ftdmiRNMS)..uc.l'mwy\, ""' 

./o.krak~~1Mf.l)li'(~l~~ 

I ~cf~u:til*l*f.IIIDOC<:LO~I. 

!~"tttkti"C!1i~,n."Y ..... i.bttm~~~~ 

.U•U:t)-'•~IIIXIII~fri.~~~ ~~ 

~-~<eabriqaanalo)bft.IIQW~CJt-.. 

~- r«rw.~~ )t.lfhw6J..~"'e.WmlfliDI1.• .. ,~"( 

<dirr:t~~&•IIGi:C~G~J.a.J.U'J'~t.iktt...,.....ucamM.ut 

~""'~.),:<.~-~-~)(~~ 
199 


71718054.eps

52 PARTJ: SUM\~RYOf ECONO~IIC PROitCTIO:<S 

Figure J.A. Dislribu1ion or panicipants proj<ction.for 111< chan~ in rtal GOP. 201S-20aoo om <he longer run 

~IS 

~.~~ -IS 

-11 

_, 

- ll 

-10 

~---,n =! ...---,~~n =: ! c===J L____j -~' I 

u 

u .. 

1.1 .. .. 2» u z., 2.1 l.J !J 

Ptrmlt rang.:-

... ,., ... 

u ... 

1.9 

2.0 u !~ 

!I U .!.S 

P'M.\'fltr.ltl~ 

- -~ = "=='I ----· I = rr=:J..!!....__!_ c=JI 1..& l.t• IJ 2.lt U 

IJ 1.7 I' ll U '"' " PtR.\'fltran~ 

~'fru.n 

U· 1.6 1-' !b U ,, IJ 11 IJ U U 

P\'f\'\>fltrang.: ~· 

'·' ,, 

ll ~· 

~ 

~.1 

,... 

,, 

" 

~· 

a 

!9 

" ,, 

J.O 

ll 

.. 

" 

J.O 

ll 

-IS 

-16 

_ , 

-12 

-tO 

-s 

- 6 _, 

11 

-IS 

-16 

_, 

- ll 

-10 

- I 

-6 

_, 

-l 

I 

'\~<{~~ 

-IS 

-16 

_, 

I~ 

-tO 

-

_, 8 

_, 

_, 

I 

... 

ll 
200 


71718055.eps

MONEIARYI'OUCYREI'ORT: JULYI018 53 

Figure 3.8. Distribution of panidpants" projections for 1hc ua.entplo)1ntnt r.ue. l01S-203nd O\W the long_ec run 

lUIS 

~r,i~~ -II 

_,, 

-I• 

I

A-----: 

r:-1_ t='L - - I 

-I~ 

- 10 

-I 

-6 

_, 

-,l ~ u ~ ~ ~ u u ._._ •• u H l.J 15 1.1 }9 AI U •• " " .. <I 

P\'fl.'\-ntran~ 

~clpwb.'1(*1t• 

lUI9 

-II 

- 16 

-i' 

-ll 

-10 

- I 

-6 

-· -,2 .. ... .. . .. ... ~., " ,_, 

N~d~ 

lUlU 

-IS 

- 16 

-i' 

- I! 

- 10 

Br--~--~ -I 

- 6 

-· I I n l7'91c::::::J r: - - I -ll 

~ ll .... .... .. .. u .. .. u ,. " ~· '"' ~1 " " •J ,_, ., .. H 

P~m'lltl1ln~ 

~~cl~ 

loagernm 

- IS 

-16 

-1• 

-12 

-10 

-s 

- 6 

=flnh~-- ~ -· _, 

I . ,. Jj. ,._ ,. u •• u .. ... •• ,. )I " '"' 11 " " " ... " u 

PM\.'fltran~ " 

Nou.:: Ddinilions of":;sri3bb 3nd Olbcr txp1an31ions 3rt in I he notes 10 13bk I. 
201 


71718056.eps

54 PARTJ: SUM\~RY Of ECONO C PROitCTIO:<S 

Figure J.C. DiSiribulion ofp3nicip3n1s projections for PCE inll.alion. lOIS-20 and owr the lollE'r run 

ltliS 

. :::~~~ 

----- ~. l I =r-------l I I l L ----- , 

ltll9 

lt)}l) 

IJ 

u 

IJ 

u 

,, 

!I 

" 10 1.1 

u 

-IS 

- 16 _,. 

-

-·~ IQ 

-s 

-6 

_, 

-;2 lJ. 

,, 

~tlpm'lf'Cb 

- IS 

-16 

-I' 

-n 

-w 

-s 

-· _ , 

I - -2 I I 

lJ. 

H 

S.-Mtl~'lPflb 

- IS 

-16 

- I' 

- ll 

-w 

-s 

- 6 

-· j l I 

r1------ : 

. . _ .... ----- -~ 1.1-

IJ I~ 

" ll !J.- 1..2 !J 

-IS 

-16 

'-----c-;--- IJ 

IJ ..l...J. u 

~ ;-- LI L! --7."""----~----' u 

~ 

lJ. 

:.~ 

~1 
202 


71718057.eps

MONEIARYI'OUCYREI'ORT: JULYIOIS 55 

Figure3.0. Oistribtltion of participanl$. projections roroore PCE inftation. 2018-20 

lOIS 

r 

I 

I 

- ,-------- J 

- I 

lOI? 

lOlO 

,, 

.. 

" OJ 

,, 

oJ 

" ,. " " 

: -------- I 1· -f ----- j I 

·~ " ,. u 

PM"Ctllr.l~ 

I I 

j-1 

11 I ... " ,. P<m1li1'3Jlgc " 

lJ 

'-' 

'-' 

l • 

lJ 

'-' 

-IS 

-16 

-I· 

-u 

-10 

- s 

- 6 

_, 

-! 

-18 

-16 

_,, 

- 11 

-10 

- s 

-6 

-· 

-/ 

;\~~(lllb.~ 

-18 

-16 

-I' 

-11 

-10 

- s 

- 6 

_, 

~! 
203 


71718058.eps

56 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S 

Figure 1 E. Distribution of panieipants' judgmmts of tile midpoint of the appropriate t<n:gtt mnge for the fedcrol 

furuJs r.lle or the appropriate l3~ttlevd for the ftdtral funds ratr~ 2018-20 and Oh.'f tile longe-r run 

1018 

- r - -nl I =I ---tCJI

t

n I r=n IU- 1..5$ !!).. !.~ ~.ft.\- ~ .ti.J.- Ul M'$- UJ.- tJ$-

u; :1: u~ !.6! :r J..l: .Ui ~ U! .fJl '~ 

1\-f\'tl'ltl'llllgt 

1019 

) 

r - , C=Jit=., tn JDElrl:c==tr -, W BS:· W- !~ W Zl$ U.J.- l..'S M.l »S- al)... .&.U IJjl !I~ Ul !.6: W )I~ IJ' W J$1 ~I! A)i U! 

Pcf\'tfltr.lllgc 

.... Ul w '" 

-IS 

-ll 

-I~ 

-I! 

-10 

-s 

-l 

_ , 

-IS 

-ll 

-t.: 

-ll 

-10 

-s 

-· _, 

_, r - ' r--1 riDs. c- 1 I. 

IAl I.SS 

U7 tu 

w 

:J1 

!~ 1A\- l# 

2.6: !Jj )12 

JU US ;.6..t )A 

J.J1 l6.! U'l 4,1! 

P~I\W~tmg.: 

"' ,., 

-IS 

_,, 

-IJ 

-IZ 

-10 

-s 

-l 

L-~~~ IM l.fi K"==T~Dr=J~~r=I lB ~ 1..6.J. ~r=l~~~~Uc=J~lli US. ~.U :us ~~~~~~~~~__J~~ l.M },&. ~B 43$ !M uS m m ~ w w w u w m w u w u m P~r«ntran~ 
204 


71718059.eps

graphical~· in the -ran cbans-shown in 

the top panels of figures4.A. 4.8. and 4.C. 

The fan chans display the median SEP 

projections for the three l'ariables surrounded 

by symmetric confidence intcrmls deri1'Cd 

from the forecast error:s reported in table 2. 

If the degree of uncertainty attending these 

projcttions is similar to the typical magnitude 

of past forecast errors and the risks around the 

projeclions are broadly balanctd. then future 

outcomes of these 1'3riables 11ould ha1e about 

a 70 percent probability of being within these 

confidence intervals. For all three variables, 

this measure of uncertainty is substantial and 

generally increases as the forecast horizon 

lengthens. 

Panicipants' assessmmtsof the leld of 

unttrtainty surrounding their indnidual 

economic projeclions are sh011 n in the 

bottom-left panels of figures 4.A, 4.8. 

and 4.C. Nearly all panicipants 1ie11td 

the degree of uncenaint)' attached to their 

economic projections for real GDP growth, 

the unempi0)1nent rate. and inflation as 

broadly similar to the 31-erage of the past 

20 )ears. a 1ie11 that was essentiall) unchanged 

from March'' 

Because the fan chans are constructed to be 

symmetric around the median projection~ 

they do not reflect any asymmetries in the 

balance of risks that participants may see 

in their economic projections. Panicipants' 

assessments of the balance of risks to their 

economic projcttions are shown in the 

bottom-right panels of figures 4.A. 4.8. and 

4.C. Most participants judged the risks to 

their projcttions of real GOP gr0111h,the 

unemployment rate, total inflation. and core 

inflation as broadly balanced- in other words, 

as broadly consistent "ith a symmetric fan 

chan. Compared with March. e1·en more 

19. Atlh:rndoftllisSUilllllat).thcbo\"Fo"''all 

~IK'<NlDI) ·discusses lh< sourm and IDtcrpmtioa 

or uocnuiot> ..,..,.,..jiQ: lh< .....,_;., btcoSt> and 

npbJo;th: opproodl us.d 10 *""" th: ""'""""'> :ud 

n>l:uurndll& lh< panicipaAI>' projcruonl. 

M().\EIAAYPOlO~EPORT: MYl018 57 

participants 5311 the risks to I heir projct1ions 

as broadly balanced. Specifical~ . for GDP 

growth. only one participant 1iewed the risks 

as tilted to the downside, and the number of 

participants who viewed lhe risks as tilled 

to the upside dropped from four to 1wo. 

For the unemplo)menl rate. the number of 

panicipanls 11ho sa11 the risks as lihed toward 

loo readings dropped from fourto 1wo. For 

intla1ion. all but one panicipant judged the 

risks 10 either lola! or core PCE price inftation 

as broadly balanced. 

In discussing the uncertainty and risks 

surrounding their projections, se1·eral 

panicipants continued to point to fiscal 

dewlopmenls as a source of upside risk. 

many participants cited de.dopments related 

to trade polic) as posing downside risks to 

!heir gr011th forecasts, and a fell' participanls 

also pointed to political di!\-elopments in 

Europe or the global otulook more generally 

as downside-risk factors. A few participanls 

noted that the appn.'Ciation of the dollar 

posed downside risks 10 the inflation ou1look. 

A fi:\1' participants also noted the risk of 

inftation m01ing higher than anticipated as I he 

unemployment rate fall~ 

Participanls' asses>ments of 1he appropriate 

future path of the federal funds rate were also 

subject to considerable uncertainty. Because 

the Committee adjus1s the federal funds 

rate in response to actual and prospective 

de1-elopmen1s 01er time in real GOP gr011 lh. 

1he unen1plO)ment rate. and inftation. 

uncenainl) sum>unding I he projected path 

for the federal funds ra1e importanlly rell«ts 

1he uncertainties about the paths for 1hose 

key economic l'ariables. Figure 5 pro1·ides a 

graphical representation of this uncertainty. 

plotting the median SEP projection for the 

federal funds rate surrounded by confidence 

intervalsderi1'Cd from 1he resuhs presented 

in table 2. As with 1he macroeconomic 

111riables, forecast unttrtainty sum>unding I he 

appropriate palh of the federal funds ra1e is 

substantial and increases for longer horizon~ 
205 


71718060.eps

58 PARTJ: SUM\~RYOf ECONO~IIC PROitCTJO:<S 

Figure4.A. Ull(<nainl)' aoo risl<sin projo:tiOliSofGDPgrowJh 

Med~n projection and ronfiMnre inttl'\'31 based on historical for«a~t trrorS 

Chan~c in rt31 GOP - M~i#lcl~ll~'ticwts 

~~;,.,ol 

2(l]J l(IIS 2(116 

_, 

-) 

-I 

-· 

2(111 2(118 2(11? 

FO~iC panicipants' assessmenlS of unccrtainl)' and risks around 1beircwnomic projections 

~ ... 1/(f\1(\>.~' 

UBt.~nainl~' 3'o¢ut GDP 1h 

0 lr:o:lM\'i;\'1..-os 

~· M3!1."b~P,'tiod~ -IS 

-1~ n· . I -ll I - 10 

I I - I 

I I - ~ 

I - ' r:==-=:' ]2 

B:N~dl} 

$mibr 

H1gh<r 

Risl:<toGDP.gt0\11ll 

0 J\ltiC'~j<\'1ioM 

•• ~btrllproj.'\~ -IS 

-10 

_ n -tJ 

--- 1 -·l - 10 

_ I I =: - I L.. - - - - 1- ~ 

~r===l l 

\\<ig!ncll!o Broodll· \\<is)lt«l!o 

doo._ b.mn<\~ up<i« 

NQJf: The bl~.t: :mJ n:d liocs in the lop p;md shCM :x!u:\1 \':lltxS 3r.d m.:"ian ~1N ''Jlucs..I'\'Sf>.'\."'ti\tfy. o( lk p:Tl..\'111 cfttnp: 

in n.".ll ~domeslic prodLtrt.'1 (GOP) rn'Kill~ fourth Qlllrtn t:i I~Jlft\ious >t3r 1o 1~fQtlnb qlllttcr of the )'C3:r iOOiclt\"d.'J'h:o 

l-onf'lli"aCtinttr\'a!3rooOO 1bt l'Do."diatl ~'ltd \'af\Ksis~~lotltsymR'l('tricaOO 6NSI..'doo tool ~nsquarcdttTOtSof 

\"Jriou:s pm'iUt and p.l'tlUTICilt fom:asts 1034: 0\Yr the f!C\"!olo~ ~ )'C3J'\: mort information 3boulll'...~dat3 i:$3\-:u"bbk in 13.tk l . 

lko~C1lrrtntro00iliMSma difftr [n,xn ~ th3l p«''likd.on :r.tragc.O\\'t'ID:pm ic)us21))'t31'S.I~\\idlb!od~ Oftbt 

coo~irttm'3leslimau·doa thc~oflhc hlil<lrir.ll fo~ error& flU)' 001 reB.'-.'1 FOMC p;li'1Xir4.nts' cut'mll ib.~"!'nmts 

olthcui)..'WUinty3ndri..J:s:tl'\)l)r.dthrirproj.'\.1iol'l5;the$c('lJrn.TJt8SSI.'S....m..."ttU3reSummaM-dintho.:-lo'.lwpaD."k~· 

sp:akin-g. ~rtiti~nts\\flo Pfgllx' ui'IC('fUjnt)'aboutll!tir ~'tionsas"~.sinUiar~lo the:-&\~ k\'dsoil~~ 

lO)(OlfSV.Wld\icv. Lhc wi.Jthof tbc<'OOfkim.~ iDI«\"JI~l' in l.bc-hislorical (~l'ld'lar13S la~~ ronsiskclt wilh thcira~'if!X'rt1$ 

of lhc tlnctftail'll)'aboutthcit(M'oj.'-.'lions.li1'('4ist_('1ni..;t-atlt$111'1\ojudSf the ~SIO lb..'ir pro_ic\'lioi'Ji>U~btood~ babflctdR 

V.'OWd'icu.' t,hc('()O;f~" intm31arooadlhrir ~'tions:asapproximatd) S)mmctric. Ford.:tiRltioosof ~ntyand risk.sia 

«vnomic projc<1ioo< S« Jhc bl11 ·fon'!'3!1 Uno:ruioJy.· 
206 


71718061.eps

MONEIARYI'OUCYREI'ORT: JULYI018 59 

Figure 4.8. Uncertaint)' and risks in projel.~ions of tbe unempfoyment rate 

MM~n projt'clion and oon~cnct inte"'31 baSr."d on hi!lotOrieal fon.'ClSI errors 

UI'IC'tnploym,•tn r:uc - - kdt.Ulof('(llj_'\'ti'Ci 

10Cia.~iotm:;tl 

201) 2014 lOll 2016 Wll WIS l019 

FOMC panicipams·a~nts of unctruinty and risks around their coonomk pro;.'ttions 

:...~ot~ 

U~inl) about the Utl(11)plo)mrnt rate 

0 hzn.:proja.1iorb 

: •• ~ludlrn.i-"-"tioos - IS 

-10 

I -u 1 - 10 

I I - I 

I I - ' 

-' 

RL4:s to the uncm(\lo)TOO!t me 

0 Jun.:~"tiocb 

: - - ~bn:bJiroP,'tions 

- I - I 

- 10 

- ! 

-8 

- I 

-· -5 

_, 

-) 

- l 

-1 

WlO 

-11 

-10 

_,. 

-12 

-10 

- s 

-. 

D -' ' _,. I I J l =r====:' I n

-- ; -r ----1 1 

r lr------,_1= Jl 

\\'cigt'I!OOto 

u..,;d< 

Non:: Th:'bhxandn:dl l'IC'$inthctop(Xlndslw.Y,., :.«ull,'ai~XSandtl'IC'dianrroj«1cJ ~I\."SJ).'\"tiw{)~oftl!cll\~ 

ci,ifun unemplormcnt r.uc iD the-fourtbqua.rh:fof tbc )"tar ir)(Ht'3ted. TbcoCOJI&kw.: inur.-aJ arl.)\ltld 1~ m.'di:ln pro~"-"ted 

\'J.h.h."S is 3..~ to b-.:' ymmctrii: and is Nscd on root m..~ squal\"d etl'l)N.Of \3rioUS pri\':l!e and gO\'tml't'l('tll fol'(\"'3.S1Sf~Ud..:' 

0\<tr tho: Pf'.'\ious ZO )'(3~ more inroonation aboot tbcstdal:1 is <rL-;aibbk in table 2. 8."CJ.Usti.'UtMltoond1tions nuydiiTcr from 

those-that PJI."~ik\1. on 3\'t.'r.lg\'. 0\Tr t~ pmi®s 20 )"ta.~ I be v.idtb and 4\ap: or tbc ronfld...-oo.· int('r.'J) c-;:!im3t«< 011 t~ oo...t~ 

ofthcllistorid(oi\'\"'3$1.CrrorsmayDOII'dl«tfm. Cp3RK-ip;tniS'C111'rtn.t1_~1Softhtlllk'tnairnyandrisksarou.OO 

dx1r proj:~tions I~CUm'ftt :aSSI.'S:!mcnts ar.:SI.LJJlm:IM:d in the lov.yr raocl'\ Gmc1al~· r-:-~in~ JQniri~nts v.-l'lo jOO~ 1~ 

Un..'\'ft3int) J.boutthtirpl'Oj..'\1io13$3S ybrc.'d~ $imi1ar''tothca..~ k\tl$00thcptSt 20 }\'31'$ would ,'i(y, thc,'idthoftht 

oonf~ inlm"J:I sbov.·o in lbc hi51oriraJ (an chan :LS br&'Cl}'~"'nsistrnl 'Aith their :15<ii."SSmefllS of the U!k'CI13.iiUy aboottbc:ir 

proj..~ion.." LikC'II·i:st. liriJl3nlS\\1'tojudg(' the ~k'i 10 their pt!)j<\1iori(3'S ""br«ld~· lxlh!X\.'d-v.I)!Jkl \~the@~ 

iml"\'llarouDd thtir p."Oj.."dions asapproMmatrly S.)mmctril.'. For d~finitioMor LLnctnaint)' and risk~ in crot~omio:-pro~tlons. 

~-.:the bo.\ •foM."l)t UIK'>.'>fUinl)~-
207 


71718062.eps

60 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S 

Figur( 4.C. U11cwta.inty ;md risks in proje\:l.ions of PCE inflation 

PCEinllalion 

- Molilncfpcj.\"li.., 

ro'..o ~intcnll 

lll4 lOIS 2!116 

-l 

-l 

-I 

-o 

2!117 lOIS 2019 l)ll) 

FOMC partkipams· a~nlS of unttnainty arK! risks around their ~!\~nomic proj«tions 

~~~~ 

Unocrtainl)";about PCEinfla.~ioo 

0 JIJntrro.J(\'tiQM 

·· Mal\'h~ 

I I 

I I 

-IS 

-16 

_, 

- 1! 

- 10 

- I 

- 6 

n----: 

-' 

: := J' [ 

8roodh· 

Simibi 

Ull(Xnainl)'aboutC'Cirt PCE inftation 

0 Jll!IC'~"'"iom ... h:J\'hfllll1-\'tiotb 

I I 

I I 

-IS 

-16 

_, 

-ll 

-10 

- s 

- 6 

[ 

---- : 

: :c===:? j; Hi!M 

Rl4s to PCE infl3.1ioo D Junt~'tioM 

•• arrllpro;x~ -II n -16 

_, ~' " 

- 10 I I _ 8 

I I - 6 

I L.-- - - .---

]2 

Risks to tore rcE il'lllation 

0 Junc~~"t)om 

•• Mal\tpr~'tiorb 

\\tiglnoloo 

•r;i<k 

- 11 n -16 

_,. , _, I I =

1

: 

I I - 6 

I L.----.-~ c===? ', .. 

Kou:Tf'x' btuc:md mlliibt$ in l.bc toppanri ~ 3<1ual'lo~3-nd rM.Iian proj.\"t~'\1 \altJ<S. t'\"Sf'.\1i,\iy.olt~~l\'\"ffl<'lta.n~ 

in tb: rri:c indc-\ for (I('I'SO!Ukoasump~)oa C'.\P.,'Oditi!KS(PC'E) from the fotlnb ctW11et of till: pmiollS )W 10 liM' founh \l~n.Cf 

ol'thc )~rind~t~. Tbt\vnfl&n.x intm';l]:uound I~ medial! r~\'t«< \"J;!ucsis3S:Sl.lm.'!J to be ~mJ'l\.1rioalld is ~Ofl r004 

mc3n squa.i\'1:1 mors of \-arious pri\'3tt' and $('\'C't'IUilCQ\ foi'(\"3S!Smadc 0\\'1' I he pmiou..:20 }\'a~ mort information about th<'sc 

dau isa'\'J.ilaJ:kint3bk l.lk'\"3118«Jmtltc:ooditlons~ dilfc-rrromthosc tlu\ (lm~il.:d. OIU\~ 0\'tf tl\t:pmioi.IS 

20 )'tJI). t~ •'XIth and sb.l~of t~ C'OO:fl'lk"IIIX iottn-al ¢SLima.tOO Ofllhc b.l$iiQ( the historil:all'om."'.l)l crron l'll3fi'IOI rtfk.."1 

O~IC rarticirarltS' ~rm:JI3~'71K1llso( tlx' Wli."(rl3int)' :~00 risks aro\Jod their projroioos.: these-~mnt a:sscssmrnts arc 

SllmmarUOO in 1~ ltM'tr pane-b. Gcctr.a!l)• ~3kirt,g. J"lrticlp.Jnts v.ho jud~ the IIIK\'f13illt) 3bo'Uithcir proj•,"1ioas 3$ -broad~· 

simibr~to ~a\'tf"lg(' lt\'t'l~<lftlkop3S120 ~\"!N v.\)uld ·~ tht 1o1iodth oftMoonli~i um::alsbmm in tlt.:: lti)lorit.tl f:ao 

clu11 a.s I;~~A>ci)'C'OnAA(tlt •itb thdr a..~'lltmts oft~ UI'IC('rtaint)'31xxlttlk-ir proj.,'tion!<.l.imi.;c. p:~l1iripotr:t $ who jud~ 

~~ ri~s to thtir rrojt\.'1ions a~ brood~· NlltK·t~r woold \'icv. t~oo-1lf.xi..."''Kt inttn"ll3routld tt.:ir proj«tioM.a:s :tppro~m:ncl) 

S)mm.mic. For d:titlitioo$ of UIK\'f13itlty and ri.J:s in trofiOmil: pro~'tiol\-;.. sc.: the bo~ ~Fortcasl UDC.\'ft3int). ~ 
208 


71718063.eps

MONEIARYI'OUCYREI'ORT: JULYI018 61 

Figure 5. Uncertainty in projections or the federal funds rate 

Median proje<oion and .;onfidenc. in<er\'al based on histori<al forecast errors 

r .. "Ckralfuodsr.llc 

)l~t<i>loiWJ<tl1!ll< 

- M~\I~ol~'1-

N'-• iri1C'f'-af• 

:!014 21116 

- 6 

- s 

_ , 

-J 

-l 

- I 

-o 

lOll lOIS 2019 

Non;:Thc-bi\X'nd 1\-d li!b..'$3rc b.l...-doo :K1U3I ,:lf'ues:and IJ'IC'diln prot-'1.1«1 l'3!Uo.'S. n.-.:p.."Cli\~,of the Commiu«-'SI;tfld for 

the fcdcralfur.ds rate at tile: end of the )'Cal iDd.icaltd. Theac1ua! ''J.tucs:utth<' midpoint of tbela~'t ran~-: tllc ITIC'diao proj.'l.'tcd 

,3J~"Sar( N..~'domcit"'ftllc midpoint of th-:13.1\'(1 rnn~orthcta~~ k\\'l. Th:('OJ!r».-nreiPim'JI;uound thcfl'll."d1<<r:~ pr()~'fOO 

''3ll.li:S~b.1..\l'donr001 n'K'3.nsqu.li\'CI.~"frot'Sof,lrious pri'..ucandg<n'l.'f(ll,'l'l('ll:t fo~m:tdcoo.ttlhc p!\'\io\1$ :'0)'1.~ l'l:h: 

l-onfldm.'C intm'al is 001 :.tMtyro:Nstrnt OJ.ith the rro;:cioos for tb: fcdml fu.nds r.ne. primari~· lx'\"3~ t~ pro~ ions ut 

OO{(orc\"'3stsofthc5kcl~(H,It('QR)("i((wthcf«k~fundsratc.b.Jt~t..:Jpro;.'\-tionsofp.,~t.ip;ult,'indi,iduaJa..~.;m:nts.of 

3Pf1C0priatc mooct31')' pol).."): Still, hi:storic3.1 fon'\"J)I crrorspn)\idc i btt»d SIC'n..;o: of~ ur.."'!dainl)' :around L1lc future path o( the 

f~ fWlds:ratc ~'fl("r.tb:d b) tbruiX\-rtaintyabout the macroo."'OOO!lk,"Jfilbksa.s OJ.~Ias.~Jdition:lladjlbtn._>fltslomOOI:tar)' 

pol~'}· that ma)·bc :~ppropri.llc 1oo1T~ thcdTC\:t,~or ~..:~tolho:ct\XIOill): 

"fll.: ronftdc~Kt in1~r.<tl is ;nslJmed to be S)'ll'lmctric ti'<CXJI'I Men it is tru1K'31cd at wo-thc bottom of the~~ t3~t rany 

for the ftdcratfur'll.kr.11~tba1 has b«nadoptlid in tho.-Jm~ b)' tMCommincc This tnJIIC3tion '>'ould not ~intrndcd to indk.OlC' 

the likdi!\ood Of tbc U$C O( IICgJtii'C iniCJ'C)I talC$ tO prO\ ide additional ll'!Otll.13~' J»!icy 3C('(Immod31iOn if dOing $0 \\'3$ jlldsc<f 

3pJ)ropriatc. In s:Lll.il situatiion5.1bc Com mitt~ rouldalsoc:mplo)• ottk.'f toot' induding fOt\\-atd gtOOanct and brgc«aac: ~ 

~1\ilas<'\ to pfO\idc addi1io~ 3t\'Ommodltion. lk\;JuS~: '""rftflt N!Dditioa~ · dilfcr (rom t~ th31 pl\"l'likd. on 3\mgc. 

<»<tr t~ pre\ious 20 )~3rt\ the 'Aidth :1~ ltl~ of th¢ tontidctle'C in ten a! estimatt'd oo the-b;lsis or tht historical fur('('l:~-t crnm 

rrAy-not 1'1.'11«1 fOMC JKir1~;p;~nu:'amtn1 015'S(').""'l\(f(1Sof tM U!Ktrtainl)' a~ risks :m~u~ thcir projections.. 

'Th:~'Onf'xf..-nreintcn~ is&.-.m\"dfromfofl.\4stsofthc-r.mg<~dof~·t«min[('ri."St~atcs nthtfounh~~olthcrear 

iOOi.:lttd! roorc il'lfomwion :ab<nn thc!.r clau is 61'3ibblr in ublt 2. Tht shaded 1~ cnootnp.usd ~than 1 7IJ pM't'l'lt tooflddh."t 

irum-aliftbt-oo~in1tn~haslx'\'nlnJIX"Jlcd:atw\\ 
209 


71718064.eps

62 PARTJ: SUM\~RY Of ECONO~IIC PROitCTIO:<S 

Forecast Uncertainty 

The «onomic proj«tions provided by the mernboo of 

the Boord of Go"ernors and the presiden~of the r.deral 

Res«ve 8an~s infO<m discussions of monet.l')' policy 

among policyma~e<s and can oid public unde<standing 

of the basis f01 policy actioo~ Considerdble uncettainty 

attends these projection<, howe.1'<.lhe «onomic and 

statistical models and re~tion>hips used to help I~OOU<e 

«onomi< iO<~IIS are n«ess.lrily imperi«t descriptions 

of the real world, and the future path of the e<onom)' 

can be affected b)• myriad unfo!eseen developmen~ and 

e.-ents. Thus. in setting the stan(e of monet.l')' policy, 

participan~ coosic:lef not on~~ what appeMs to be the 

most likely«onomicoutcome as embodied in their 

projections. bulalso the range of altemato-e possibilities, 

the likelihood of their occuiTing. and the potE<ltial cOilS to 

the «onomy should they occur. 

Table 1 sumnl.lrizes the "''"&e hiiiOricalaccuracy 

of a "nge of fo<ecasts, including those r<iJ011ed in pall 

Monelary Policy (lppottsand those prepared by the 

r.deral Restn'O Boord's staff in advance of meetings of the 

Federal Open ,\Iarke~ Committee (FOMQ. The proj«tion 

error ranges shown in the table illustrate the conside,.ble 

uncertainty associated with eoonomic focec.cnts. For 

mmple, suppose a l"~icipanl projects that real groo 

don1<1<tic product (GOP! and wt.JI consumer prices will 

rise steadily at annual rates of, resp«ti\'ely, 3 percent and 

1 percent. lithe uncert.lin~· attending those projection~ 

is similar to ihat experienced in the past and the risM 

around the projections are broodly balanced, the numboo 

r<iJ011ed in table 2 would impl)' a probability of about 

70 percenithat actual COP 1\0Uid expand within a range 

of 1.7to 4.3 percent in the current )'Oar, 1.0 to 5.0 percent 

in the second 1-ear, and 0.9 10 5.1 percent inthe third 

)'Oar. The corresponding 70 percent confodence inte<v.ols 

fO< 0\'0!all iniLltion would be 1.3 to 1.7 per<E<lt in the 

current 1-ear and 1.0 to 3.0 percent in the second and third 

)~ars. ~gures 4.A through 4.C illustrate these cooodence 

bounds in •f.n cha~!" that >re symmetric and centered on 

the me<lians of fOMC pa~iciP"nts' projec1ions for GOP 

groMh, the unemplo) ment r.ne. and inilation. Howe,~. 

in some instances, the risl:s around the projedions. may 

not be srmrneuic. In l"~icular. the unemployment rate 

cannot be negath~; fu~hermore, the risM around a 

pa~icular p<Oj«tion might be tilted to either the upside or 

t~ w,,·ns~, in 1\lti~h em the ~orresj)Qil(ling ian cha~ 

1\oold be asymmetrical!)' positiooed around the median 

projectioo. 

Because curreot conditions ma)' differ from those th.lt 

prevailed, on "-erage, 0\'01 history, participants prOI'ide 

judgments as to whether the uoc~inty auached to 

their projections of each «onomic variable is sreater 

th.ln, smaller than, or bro.dly >imilar to typic.lle.~ls 

of forecast uncertainty seen in the I"~ 20 )'Oa~, as 

presE<lted in ~ble 2 and reflected in the widths of the 

conodence inten~ls shown in the top panels of figures 

4.A through 4.C. Participants' currE<lt assessments of the 

uncertJlm)' surrounding their projections are sumrnarh;ed 

in the bottom-left J"nels of those rlgur~ Pa~icipants 

also ptO\ide judgment> as to whether the risks to their 

projections are weighted to the upside, are 1\eighted to 

the down~de. or are bro.dl)• balanced. That i~ while the 

symmetric historical fan ch.l~s """' n in the top panels of 

figures 4.A through 4.( imply that the risl<s to pa~icipants' 

projections are oolanced, participants mar judge that 

there is a greater rislt that a gi'-en variable will be abO\-e 

rather than below their projections. These judgment> 

are sun1marized in tt'.t lrnveNight pallets oi tigures 4.A 

through 4.(. 

As with realacti\'ity and intlatioo, the outlool; for 

the future path of the federal funds rale is subj«t to 

considerable uncert.linty. This uncert.lin~· arises primarily 

b«ause each participant's assessment of the appropriate 

stonce of mone~ry policy depends importJntly on 

the e.-olution of realactivi~· and iniLltion 0\-er time. II 

econornic conditions e'\'01\'e in an unexpected mannec, 

then aSSll<ments of the appropriate se<ting of the federal 

funds rate would ch.lnge from that point forward. The 

final line in lab!e 2 shows the error ranges kw ioreca~ oi 

short·term interest rates. They suggest that the histO<ical 

confodence intervals associated with projections of the 

federal funds rate are quite wide. It should be noted, 

howe\'Cr, that these confidence intefvals are not strictly 

consilient 1rith the projections for the federal funds 

rate, as these projections are not forecasts ol the most 

likely qua~erly outcomes but rather are projections 

of pa~icipan~· ind'l\'idualassessmen~ of appropriate 

mooetary policy and are on an en<f.of·]'Oar oosi~ 

H0\1'0"er, the forecast errors should prOI'ide a sense of the 

unc~inty around the future path of the federal funds rate 

generated by the uncettainty about the macroeconomic 

variables as "•II as additional adjustments to moneta')' 

policy that would be appropriate to offselthe effects ol 

shocks to the economy. 

If at some point in the future the confidence interval 

around the federal funds rate 1\•re to extE<ld below zero, 

it would be truncated at zero fO< purposes of the fan chart 

"""'" in frgure 5; zero~ the bottom of the 10\,·est target 

ra.nge for the federal funds rate th.lt has been adopted 

by the Committee in the past. This approach to the 

construction of the federal funds rate fJn cha~ "oold be 

tneftlr a C::M\'elllioni it \\ould not ha\'e an)' implications 

for pofiible fvt\Jie polity deci~QOI regarding~~ u~ ol 

negati\-e intertslta:es to ptovide .!dditional mone1ary 

policy accom~tion if doing so""'" appropriate. In 

such situations, the Committee could also en1ploy Olher 

tools, including forward guidance and asset pmch.1ses, to 

prOI'ide additional acconm10dation. 

While frgures 4.A tluough 4.C prOI'ide infomnation on 

the uncert.lint)' around the economic projections, figtJre 1 

prOI'ides infornl.ltion on the range of vie"' across FO.\\C 

participants. A con1parison of figure I with figures 4.A 

through 4.C """'' that the dilpersion of the p<oj«tions 

across participants is much smaller than lhe Cl\-er.age 

forecast errors"'"' the !"It 20 rea~. 
210 


71718065.eps

ABBREVIATIONS 

AFE 

BBA 

BLS 

C&l 

Desk 

DPI 

ECB 

EME 

FOMC 

GDP 

IOER 

JOLTS 

LFPR 

MBS 

Michigan survey 

OIS 

ONRRP 

PCE 

SEP 

SLOOS 

S&P 

TCJA 

TIPS 

VIX 

ad\'anced foreign economy 

Bip.1nisan Budget Act of2018 

Bureau of Labor Statistics 

commercial and industrial 

Open Market Desk at the Federal Resen·e Bank of New York 

disposable personal income 

European Central Bank 

emerging market economy 

Federal Open Market Committee; also. the Committee 

gross domestic product 

interest on e.1cess reserws 

Job Openings and Labor Turnover Survey 

labor force part icip.1tion rate 

mortgage-backed securities 

University of Michigan Sun·eys of Consumers 

O\'ernight index swap 

overnight reverse repurchase agreement 

personal consumption expenditures 

Summary of Economic Projections 

Senior Loan Officer Opinion Sun'C)' on Bank Lending Practices 

Standard & Poor's 

Tax Cuts and Jobs Act 

Tn.>asury lnflation-l'rotected Securities 

implied volatility for the S&P 500 index 

63 
211 


71718066.eps
212 

ARTICLE SUBMITTED BY SENATOR BROWN 


71718067.eps

Paychecks Lag as Profits Soar, and 

Prices Erode Wage Gains 

Julyl3,2018 

Corporateprofits have rarely swept up a bigger share of the nation's wealth, and . 

workers have rarely shared a smaller one. 

The lopsided split is especially pronounced given how low the official unemployment 

rate has sunk. Throughout the recession and much of its aftermath, when many 

Americans were grateful to receive a paycheck instead of a pink slip, jobs and raises 

were in short supply. Now, complaints of labor shortages are· as common as tweets. For 

the first time in a long while, workers have some leverage to push for more. 

Yet many are far from making up all the lost ground. Hourly earnings have moved 

forward at a crawl, with higher prices giving workers less buying power than they had 

last summer. Last-minute scheduling, no-poaching and noncompete clauses, and the use 

of independent contractors are popular tactics that put workers at a disadvantage. 

Threats to move operations overseas, where labor is cheaper, continue to loom. 

And in the background, the nation's central bankers stand poised to raise interest rates 

and deliberately rein in growth if wages climb too rapidly. 

Workers, understandably, are asking whether they are getting a raw deal. 

"Sure, you can get a job slinging hamburgers somewhere or working in a warehouse," 

said Christina Jones, 53, of Mobile, Ala Ms. Jones spent eight months searching for a job 

with living wages and benefits, after being laid off from a paper company where she had 

worked for nearly 13 years: Dozens of interviews later, she land~d work last month at a 

concrete crushing company as an accounts payable clerk for 514 an hour-two-thirds 

her previous salary. 
213 


71718068.eps

"You hear, 'Oh, the unemployment rate is as low as it's ever been,'" Ms. Jones said, but 

"it was discouraging." 

Businesses have been more successful at regaining losses from the downturn. Since the 

recession ended in 20G9, corporate profits have grown at an annualized rate of 6.5 

percent. Several sectors have done much better. On Friday, for example, banks like 

JPMorgan Chase and Citigroup reported outsize double-digit earnings in the second 

quarter. 

Yearly wage growth has yet to ltit 3 percent And when it does, the Federal Reserve -

which has a mandate to keep inflation under control even as it is supposed to maximize 

employment- can be expected to tap the brakes. 

Labor's Declining Share 

Workers' paychecks account for much less of the nation's total income since the last recession, 

and the profits of businesses account for more. 

Employee pay as a share of national income 

68% 

67 

66 

65 

64 

63 

62 

61 

60 

1970 ·so '90 2000 '10 '18 

Corporate profits as a share of nalionaf income 

15% 

14 

13 

12 

11 

10 

9 

8 

1970 ·so '90 2000 '10 '18 
214 


71718069.eps

SOurce: Bureau o!Eoonomic Statistics I By The New York Times 

As Fed policymakers have explained, allowing the economy to run too hot "could lead 

eventually to a significant economic downturn." And persistent wage increases, unlike 

growing profit margins, are considered a signal that the heat is on. 

The bank's primary method of cooling the economy is to dampen spending and investing 

by raising interest rates and making it more expensive to borrow money - an antidote 

that could hurt profits in some sectors as well as trim payrolls. The thinking goes like 

this: Better to inflict some pain now, in the form of higher joblessness and sluggish wage 

growth, than to allow more pain later. 

After keeping benchmark interest rates at near-zero levels during the recession, the Fed 

has been gradually nudging them up. So far this year, it has raised rates twice. 

With tariffs piling up and potentially pushing prices higher, odds are that the Fed will 

push through two more increases before 2018 ends. The Labor Department reported this 

week that one inflation measure, the Consumer Price Index, had increased 2.9 percent in 

12 months - the highest level in six years. 

Discomfort with a tight labor market and growing worker bargaining power is to some 

degree baked into the Fed's makeup. Pressure to raise wages during expansions will 

inevitably be seen as precursors to insidious inflationary pressure. 

The conventional wisdom that higher wages inevitably lead to higher prices, however, is 

flimsy, some economists argue. 

"It theoretically makes sense," Michael R. Strain, an economist at the conservative 

American Enterprise Institute, said of the link between wage increases and inflation, 

"but empirically, it's increasingly difficult to find a real strong link." 

A study by the Federal Reserve Bank of Cleveland, for example, concluded that "the 

connections among wages, prices, and economic activity are more akin to a tangled web 

than a straight line," and that "the ability of wages to help predict future inflation is 

limited." 
215 


71718070.eps

A tight labor market shoulod give workers some leverage to push for higher wages, but hourly earnings have 

moved forward at a crawl. Olristie Hemm Klol< ror'l11e New YorS< Tunes 

Regardless, there is plenty of evidence that workers have yet to receive their fair share 

of this most recent expansion-or even the previous one. 

Since the century's start, labor's share of the nation's income has sunk to the lowest 

levels in decades. 

In 2000, when the jobless rate last fell below 4 percent, corporations pulled in 8.3 percent 

of the nation's total income in the form of profits; wages and salaries across the entire 

work force accounted for roughly 66 percent 

Now, the jobless rate is again fluttering below 4 percent. But corporate profits account 

for 13.2 percent of the nation's income. Workers' compensation has fallen to 62 percent. 
216 


71718071.eps

If workers' share had not shrunk, they would have had an additional $532 billion, or 

about $3,400 each, said Jared Bernstein, an economic adviser to former Vice President 

Joseph R Biden Jr. And at this point in the recovery, shifting some of those corporate 

profits to workers would have no effect on inflation, he noted. 

In the tug of war between workers and irtvestors, Americans livirtg on a paycheck have 

seldom been left with a shorter end of the rope. 

Fredy Amador has spent years working for various temporary help agencies, packing 

boxes of baby clothes, quality-checking packages of popcorn and doing other work at 

warehouses across the Chicago area Despite what he says are frequent promises of 

permanent work, he has never been able to escape temp status. 

Recently, his situation got worse. He used to receive holidays and paid vacations, he 

said, but the agency that offered them lost its contract to another firm that did not 

"They want to avoid all the benefits,• said Mr. Amador. 

Mr. Amador, 34, said he earns $12 an hour, far less than the $20 an hour or more earned 

by permanent employees doing similar work. For extra money, he drives for the ridehailing service Lyft on the weekends. "Even if you have really good skills, you have to 

start as a temp,• said Mr. Amador, who moved to the United States from Honduras 12 

years ago. "They never give you an opportunity to move on.• 

Economists have offered various explanations for why workers are not doing better: the 

steady weakening of labor unions, the ability of American companies to find cheaper 

labor abroad or automate further, piddling productivity growth and the rise of superstar 

companies that are extremely efficient with a relatively small labor force. 

The recent tax overhaul has further pumped up corporate earnings. Promises that lower 

tax bills for businesses would translate into higher wages have yet to materialize. 

Higher gas and medical care costs have eaten away at whatever gains most workers 

have made. 
217 


71718072.eps

Nor are those extra profits going into business expansion. Since the first of the year, 

American companies including Apple, Wells Fargo and McDonald's have announced 

nearly S680 billion in buybacks of their own stock, according to the research firm 

TrimTabs. In essence, they are directing a majority of the windfall to investors and chief 

executives, who tend to have large stock-based compensation packages. 

Profits are also financing foreign mergers and acquisitions." A lot of U.S. businesses are 

looking abroad to see what they can buy," said Jason Gerlis, managing director ofTMF 

Group U.S.A., a global consulting firm, "because it's easier to finance or capitalize 

offshore." 

The reason is a change in the tax law that limited interest deductibility on domestic 

investments, but not on those abroad. International deals in the first half of 2018 nearly 

doubled compared with the same period last year. 

The United States may be leading other big industrialized countries in economic growth, 

but its labor force does not fare well in comparison. American workers' share of their 

country's total output fell much sharper and faster than the average reported by the 

Organization for Economic Cooperation and Development The United States also had a 

larger proportion of low-wage workers than nearly every other member. 

When the economy was struggling, employers became accustomed to inboxes flooded 

with resumes and snaking lines of eager applicants. Many may have forgotten, or never 

learned how, to compete for workers. 

When it comes to complaints of a labor shortage, as Nee! Kashkari, president of the 

Minneapolis Fed, has said: "If you're not raising wages, then it just sounds like 

whining." 

Follow Patricia Cohen on Twitter: @_i>cJtcohenN'(T. 

Ben Casselman contributed reporting. 

A\'eBionolthisorticle"""""~prilllcoMy 14, 2018,on PqoAI ollheNewYor1<ecilionlli1ti lheheadlint: Prolltss..11,8ut Labo<!I$SeeNo 

Re:ief