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[Senate Hearing 114-11]
[From the U.S. Government Publishing Office]

                                                         S. Hrg. 114-11

           EXAMINING THE REGULATORY REGIME FOR REGIONAL BANKS

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED FOURTEENTH CONGRESS

                             FIRST SESSION

                                   ON

 EXAMINING THE IMPACT OF THE EXISTING REGULATORY FRAMEWORK ON REGIONAL 
                                 BANKS

                               __________

                             MARCH 24, 2015

                               __________

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

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                          Washington, DC 20402-0001
                                          

            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

MIKE CRAPO, Idaho                    SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois                  JON TESTER, Montana
DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
JERRY MORAN, Kansas

           William D. Duhnke III, Staff Director and Counsel
                 Mark Powden, Democratic Staff Director
                    Jelena McWilliams, Chief Counsel
                       Beth Zorc, Senior Counsel
                Jack Dunn III, Professional Staff Member
            Laura Swanson, Democratic Deputy Staff Director
                Graham Steele, Democratic Chief Counsel
                       Dawn Ratliff, Chief Clerk
                      Troy Cornell, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor

                                  (ii)

                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 24, 2015

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     2

                               WITNESSES

Oliver I. Ireland, Partner, Morrison & Foerster..................     4
    Prepared statement...........................................    31
    Response to written question of:
        Chairman Shelby..........................................   211
Deron Smithy, Treasurer, Regions Bank, on behalf of the Regional 
  Bank Group.....................................................     5
    Prepared statement...........................................    35
Mark Olson, Co-Chair, Bipartisan Policy Center Financial 
  Regulatory Reform Initiative's Regulatory Architecture Task 
  Force..........................................................     7
    Prepared statement...........................................    62
    Responses to written questions of:
        Senator Reed.............................................   213
        Senator Vitter...........................................   215
Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, Mit 
  Sloan School of Management.....................................     8
    Prepared statement...........................................    66
    Response to written question of:
        Senator Reed.............................................   216

              Additional Material Supplied for the Record

Letter submitted by Bryan Jordan, Chairman, Mid-Size Bank 
  Coalition of America...........................................    71
Letter submitted by William Moore, Executive Director, Regional 
  Bank Coalition.................................................    74
Wall Street Journal article, ``Fed's Lockhart Endorses Raising 
  $50 Billion Level for Tougher Bank Rules,'' submitted by 
  Chairman Shelby................................................    76
Wall Street Journal article, ``Deep in the Rust Belt, Regional 
  Banks Fill Industrial Niche,'' submitted by Chairman Shelby....    78
Banking Perspective article, ``Section 165 Revisited--Rethinking 
  Enhanced Prudential Regulations,'' submitted by Chairman Shelby    88
M&T Bank Corporation's 2014 Annual Shareholder letter submitted 
  by Chairman Shelby.............................................    97
Columbus Business First article, ``Cleveland Fed Chief Mester 
  open to adjusting tiered banking regulation,'' submitted by 
  Chairman Shelby................................................   114
Prepared statement of Greg Becker, Chief Executive Officer, SVB 
  Financial Group, Inc., on behalf of Silicon Valley Bank........   115
Letter submitted by Heid Mandanis Schooner, Professor of Law, The 
  Catholic University of America, Columbus School of Law.........   122
Letter submitted by Tayfun Tuzun, Executive Vice President and 
  Chief Financial Officer, Fifth Third Bank......................   125
Letter submitted by Sarah A. Miller, Chief Executive Officer, 
  Institute of International Bankers.............................   130

                                 (iii)

Bipartisan Policy Center's report, ``Dodd-Frank's Missed 
  Opportunity: A Road Map for a More Effective Regulatory 
  Architecture''.................................................   133
 
           EXAMINING THE REGULATORY REGIME FOR REGIONAL BANKS

                              ----------                              

                        TUESDAY, MARCH 24, 2015

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Richard Shelby, Chairman of the 
Committee, presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The Committee will come to order.
    Last week, the Committee continued its examination of the 
existing regulatory framework for regional banks by hearing 
from the regulators. Today we will hear from a broad panel of 
experts, including those who have witnessed firsthand the 
impact of the current regulatory structure and those who have 
analyzed this issue in depth.
    Current law subjects all banks with assets of $50 billion 
or more to enhanced prudential standards, regardless of whether 
the bank has $51 billion, $251 billion, or trillions in assets.
    Five years after this threshold was fixed in statute, no 
legislator or regulator has properly explained where it came 
from, why it was deemed appropriate at the time, or what 
analysis supported it. I believe that 5 years is long enough to 
know if an arbitrary threshold is appropriate and whether or 
not it should be changed.
    Last week, we heard from regulators that there are 
alternative ways to measure systemic risk instead of relying 
solely upon an arbitrary asset threshold.
    We also heard that the existing statutory requirements 
limit the regulators' flexibility to tailor prudential 
standards based on the actual systemic risk of an institution. 
The current framework should address systemic risk as current 
law intends. I believe there is a way to do this without 
preventing regional financial institutions from growing, 
remaining competitive, and expanding into new communities.
    Ironically, the arbitrary $50 billion threshold may create 
a competitive advantage for Wall Street institutions by 
imposing costly compliance barriers for region-based banks that 
are a fraction of their size. Instead of giving our regulators 
the flexibility to properly direct resources by focusing on the 
institutions that present the most risk, the law creates a 
clear line of demarcation based purely on the institution's 
size. Therefore, the regulators are unable to scale regulation 
in a manner that reflects a bank's risk profile and activities.
    I am concerned that a regulatory system that is too rigid 
imposes unwarranted costs without enhancing safety and 
soundness. These costs are then passed along to consumers and 
businesses by restricting credit and other financial services. 
Restricted lending means slower growth and fewer opportunities.
    The ideal regulatory regime should allow for the maximum 
level of economic growth while also ensuring the safety and 
soundness of our financial system. It is becoming more apparent 
that current law has not struck the appropriate balance and 
that changes are in order. Today's witnesses will discuss some 
of those changes and give us the benefit of their expertise as 
we consider possible refinements to current law.
    Senator Brown.

               STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman. Thanks to all four 
witnesses for joining us.
    This hearing is important to examine the regulation of 
regional banks. It is the second of two hearings on this topic, 
and a third--an earlier one actually we had done in the 
Subcommittee I chaired last year. This is the second of these 
two under Chairman Shelby, and I appreciate the work that he is 
doing. I thought our discussion last Thursday was useful. I 
hope we can learn as much today.
    It is important we advance this conversation to ensure that 
prudential regulations for regional banks are crafted 
appropriately. It is an important topic to me personally and my 
State because three of our large regional banks--Fifth Third, 
the largest, followed by Key, followed by Huntington in my 
State, and as I pointed out last week, we had a fourth, larger 
than any of the three, that was unable to survive the 2008 
financial crisis, partly for management reasons, largely the 
economy but other things. Congress directed agencies through 
Dodd-Frank to institute standards like capital and liquidity 
and risk management and stress testing to lower the likelihood 
and the costs of large bank holding company failures. It called 
for heightened rules for large bank holding companies, but it 
directed regulators not--and I emphasize ``not''--to take a 
one-size-fits-all approach so that a $50 billion bank or a $100 
billion bank would not be treated the same way, logically, as a 
$2 trillion bank.
    We all agree that regional banks are not systemic in the 
same way that money center banks are, so we need to understand 
that the SIFI designation at 50 does not mean--we sometimes 
conflate this. It does not mean that Congress and the 
regulators think that they are systemic in the same way that 
money center banks are. The failure of one regional bank, 
assuming it is following a traditional model, will not, in 
fact, threaten the entire system. But the rules were not meant 
to cover only systemically important or too-big-to-fail banks.
    We heard from Governor Tarullo that systemic importance is 
about the failure of the institution creating a crisis, but it 
is also about the importance of an institution to homeowners 
and small businesses and the economic footprint where that bank 
operates.
    Go back again to National City Bank in Cleveland and the 
damage that came to that community and to thousands of 
employees because of what happened with that bank. Chairman 
Gruenberg told us that IndyMac's failures, of course, had huge 
consequences for its community, its region, and the mortgage 
market as a whole. Again, a smaller bank, but not systemically 
important in that sense, but important in its community and 
beyond.
    I look forward to hearing more from today's witnesses about 
these rules and their implementation for banks your size, 
especially the size of Regions, for example. I continue to 
believe we will not be successful this Congress in providing 
regulatory relief to institutions of any size if we do not have 
broad bipartisan consensus--and I underscore ``broad bipartisan 
consensus''--to do the kind of regulatory relief that most of 
us or almost all of us on this Committee want to do. But it 
needs to be bipartisan, and it needs to be consensus; 
otherwise, we will fail, I think, our financial system and we 
fail taxpayers. Our prospects are even less likely if we try to 
undermine or roll back central elements of Wall Street reform.
    Let me give you an example. Legislation that Senator 
Collins and Senator Johanns and I sponsored to tailor insurance 
capital standards provides a useful model on how we should 
address these issues. We started with the agencies--in that 
case it was the Federal Reserve--to see if they could address 
the issue without regulation. This was when a large insurance 
company owns a smaller bank and how the capital standards would 
apply. That was the issue.
    When that process faltered, going to the Fed and asking to 
change--asking for change, when that process faltered, we 
introduced legislation. We held hearings on the legislation. We 
considered input from supporters and skeptics, and there were a 
number of skeptics, including people who had helped to write 
the Collins provision initially--the skeptics initially of 
those that helped to write the Collins provision.
    After that sort of arduous task but very important to the 
legislative process, the final product of a 2-year process 
reflected a pragmatic compromise between industry and consumer 
groups that would receive the support of 100 Members of the 
U.S. Senate. That is the way to do legislation. That is what I 
hope our Committee this year will learn from our Committee last 
year. We did not allow other provisions, even though there were 
attempts, to be added to our legislation.
    I am open to solving real problems affecting actual 
institutions without undermining the safety and the soundness 
of the financial system or of any individual financial entity 
or without undermining consumer protection.
    Last week, we talked with regulators about the enhanced 
prudential standards are being applied to regional banks above 
$50 billion, which Regions and a number of other banks 
represent. Today I hope we can answer other questions, and here 
is where I think the importance of this hearing comes in.
    Are there specific standards that are inappropriate for 
regional banks and why? What standards, if any, are 
inappropriate for regional banks? And why are they 
inappropriate?
    Do the concerns being raised stem from implementing 
regulations which require no legislation to fix or from the law 
itself?
    Which concerns can be addressed by using the flexibility 
that the law applies to the--that the law provides the Federal 
Reserve with prompting by the FSOC to limit thresholds for some 
of these standards? In other words, we know that Dodd-Frank 
gave flexibility to FSOC to make determinations working through 
the Fed or working through one of the others sitting on the 
FSOC on regulation issues, and they are empowered to do that.
    Regulation is necessary. It is our job to ensure that 
regulations are appropriate. It is also important we do not 
make it difficult to monitor potential sources of risk or to 
encourage unsafe practices. Lending is inherently risky. We 
know that. Enhanced prudential standards are important not just 
as a response to the last crisis, but to prevent the next one.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Brown.
    Without objection, I would like to enter into the record at 
this time statements from the following organizations: the 
Regional Bank Coalition; the Fifth Third Bank; the Silicon 
Valley Bank; the Mid-Size Bank Coalition; the M&T Bank 
Corporation CEO Robert Wilmers' 2014 Annual Report to 
Shareholders, pages 8 through 14, which discuss a regulatory 
regime for regional banks; the April 2014 report from the 
Bipartisan Policy Center entitled ``Dodd-Frank's Missed 
Opportunity: A Road Map for a More Effective Regulatory 
Architecture''; and a 2014 Banking Perspective article from 
Venable LLP entitled ``Section 165 Revisited: Rethinking 
Enhanced Prudential Regulations.'' Without objection, it is so 
ordered.
    Chairman Shelby. Our witnesses today include: Mr. Oliver 
Ireland. He is a Partner of Morrison & Foerster; Mr. Deron 
Smithy, Executive Vice President and Treasurer, Regions Bank; 
Mr. Mark Olson, former member of the Board of Governors of the 
Fed, no stranger to this Committee, co-chair of the Bipartisan 
Policy Center Financial Regulatory Reform Initiative's 
Regulatory Architecture Task Force; and Mr. Simon Johnson, 
Ronald A. Kurtz Professor of Entrepreneurship, MIT Sloan School 
of Management.
    We welcome all of you. All of your written statements will 
be made part of the record. We will start with you, Mr. 
Ireland.

  STATEMENT OF OLIVER I. IRELAND, PARTNER, MORRISON & FOERSTER

    Mr. Ireland. Thank you, Chairman Shelby and Ranking Member 
Brown, Senators on the Committee. I am a Partner in the 
Financial Services practice at Morrison & Foerster, as Chairman 
Shelby mentioned. I spent 26 years before going into private 
practice with the Federal Reserve System, 15 of those as an 
Associate General Counsel at the Board in Washington, where one 
of my focuses was the issue of systemic risk and how to address 
systemic risk.
    I had personal experience with a number of severe market 
events ranging from the Chrysler bailout in 1980 through the 
thrift crisis and other events along the way, including the 
failure of Continental Illinois Bank while I was at the Federal 
Reserve Bank of Chicago.
    In the private sector, working since then, I was working 
with Bear Stearns and the Reserve Funds, both of whom were sort 
of central players in the financial crisis, and so I saw it up 
close from the other side.
    We are here to discuss the issue of an appropriate 
regulatory regime for regional banks. That issue is tied, I 
think, inexorably to the so-called doctrine of too big to fail 
that sometimes is viewed as flowing out of the Continental Bank 
failure and was evident in the bailouts of banks as well as 
other institutions in the recent financial crisis.
    Too big to fail is a bad policy. It creates moral hazard 
that distorts markets, and it is just plain unfair.
    Dodd-Frank, quite correctly I think, attacks too big to 
fail, but I think it does so with too broad a brush. The 
example that has been shown here or referenced here, the 165 
rules that trigger off a $50 billion asset threshold for 
certain mandatory requirements pick up a large number of 
regional banks that do not pose the same kind of systemic risks 
that other banking institutions impose. In doing so, they 
impose costs on those banks with traditional models of taking 
deposits, making loans, and they affect regional economies and 
households that use those banks' services by increasing the 
costs for those banks.
    A recent OFR report studying the systemic risk of banks 
over $50 billion showed wide disparities in risk by a factor of 
over 100. I think a better measure, which is basically the 
measure used by the OFR, of systemic risk is a measure that 
came out of the Basel Committee on Bank Supervision in 2013 
that looks at size, which is, admittedly, an important issue, 
interconnectedness, substitutability, cross-jurisdictional 
activity, which may actually have a little bit less effect in 
domestic economies, and complexity as factors.
    A similar system could be structured for identifying 
important banks that threaten systemic disruptions in the U.S. 
economy and could be applied to U.S. banking institutions. It 
would require some tailoring to do so.
    Adopting such an approach, however, would require changes 
to Dodd-Frank. The lockstep required enhanced prudential 
standards or more stringent prudential standards under Dodd-
Frank would require amendments to provide the regulators with 
additional flexibility.
    I would not suggest, however, that we codify any particular 
scheme. The Basel scheme is a good approach. I think it is 
better than the $50 billion. It represents current thinking. 
Thinking in this area is evolving as academics and supervisors 
alike study the issues, and I think we want to develop a system 
that is flexible going forward so that regulators can address 
risks in whatever size banks pose those risks, while at the 
same time not unnecessarily burdening banks that do not present 
the same level of risk.
    Thank you.
    Chairman Shelby. Mr. Smithy.

 STATEMENT OF DERON SMITHY, TREASURER, REGIONS BANK, ON BEHALF 
                   OF THE REGIONAL BANK GROUP

    Mr. Smithy. Thank you, Chairman Shelby, Ranking Member 
Brown, and Members of the Senate Banking Committee. My name is 
Deron Smithy, and I am the Treasurer of Regions Bank, a $120 
billion bank based in Birmingham, Alabama. I appreciate the 
opportunity today to speak to the Committee about enhanced 
standards and the systemic risk designation.
    Dodd-Frank established a $50 billion asset threshold for 
systemically important financial institutions, or SIFIs, a 
label that subjects banks to more stringent regulatory 
oversight and costs regardless of their business model or 
complexity.
    I am appearing today in my capacity at Regions Bank and as 
a representative of the Regional Bank Group, a coalition of 
community-based, traditional lending institutions that power 
Main Street economies.
    Regions Bank, which has branches in 16 States, has a simple 
operating model that focuses on relationship banking, matching 
high-quality customer service with industry expertise. Regions 
serves a diversified customer base with over 450,000 commercial 
clients, including 400,000 small business owners and 4.5 
million households. Collectively, the banks in our group 
operate in all 50 States and have credit relationships with 
more than 60 million American households and more than 6 
million businesses. Yet, in aggregate, our assets are less than 
2 percent of GDP, roughly equivalent of the single largest U.S. 
bank.
    Regional banks are funded primarily through core deposits, 
and we loan those deposits back into the communities that we 
serve, competing against banks of all sizes.
    Regional banks are not complex. We do not engage in 
significant trading or international activities, make markets 
in securities, or have meaningful interconnections with other 
financial firms.
    It is appropriate for the Committee to consider whether a 
$50 billion threshold is the best way to define a SIFI. More 
stringent regulatory oversight should focus on those firms 
whose individual stress or failure trigger or deepen financial 
crisis or destabilize the economy.
    Dealing with the issues of systemic risk is crucial. We do 
not want another financial crisis. Yet an overly broad 
definition that captures traditional lenders has consequences 
as well. These rules have a direct impact on a bank's strategic 
direction, including its appetite for specific products and its 
ability to support local economic activity through lending.
    The direct costs as well as management's time and attention 
to meet these rules create a disproportionate burden on 
regional banks. Collectively, the incremental cost of 
regulatory compliance exceeds $2 billion annually.
    Regional banks seek a regulatory framework that helps the 
country promote economic growth in tandem with safe and sound 
banking practices. Thirty-three banks are currently SIFIs, 
placing the same baseline burden on regional banks and money 
center banks alike. While the regulators occasionally tailor 
rules for the SIFI class, it is important to note that with an 
automatic threshold or floor, the tailoring operates as a one-
way ratchet only. This floor separates regional banks from many 
of its competitors.
    Now that more data is available regarding the scope of the 
Dodd-Frank regulation and the nature of systemic risk, the 
Committee can determine whether there is a benefit to having 
regional banks automatically subjected to this oversight 
regime. The recent Office of Financial Research study using 
systemic indicators gathered by the Federal Reserve highlights 
the gulf between money center and regional banks. The top six 
banks had an average systemic score of 319, more than 25 times 
higher than that average of the regional banks of 12. Altering 
the threshold in a common-sense manner will not obstruct 
regulators' discretion to stop risky behavior or weaken their 
supervisory powers. Even absent systemic designation, 
protective regulatory guard rails that have evolved since the 
financial crisis would remain in place for regional banks, 
including the capital planning and stress testing activities 
started before Dodd-Frank.
    An activity-based approach would establish a fairer method 
for supervising banks, and it would strengthen regulators' 
ability to better tailor rules and deploy their own resources 
where they are needed. Regulators have used factors including 
size, complexity, interconnectedness, global activity, and 
substitutability to determine how firms might impact financial 
stability. And like the OFR study, they reached the conclusion 
that regional banks are fundamentally different than complex 
banks.
    In the end, an improved regulatory system better aligned 
with bank complexity and risk would ensure safety and soundness 
while promoting U.S. economic growth and job creation.
    Thank you again for the opportunity to testify before the 
Committee today, and I look forward to your questions.
    Chairman Shelby. Mr. Olson.

  STATEMENT OF MARK OLSON, CO-CHAIR, BIPARTISAN POLICY CENTER 
      FINANCIAL REGULATORY REFORM INITIATIVE'S REGULATORY 
                    ARCHITECTURE TASK FORCE

    Mr. Olson. Thank you very much, Mr. Chairman, Ranking 
Member Brown, Members of the Committee. Thank you for inviting 
me to be here, and as you indicated, Mr. Chairman, I am 
enjoying the chance to come back to familiar territory.
    I am here today representing the Bipartisan Policy Center 
with my colleague, Richard Neiman, former superintendent of 
banks for the State of New York, who co-chaired this with me.
    As you suggested to Senator Brown, this is a bipartisan 
effort, and I think bipartisanship in looking at this issue is 
particularly important. And thank you, Mr. Chairman, for 
including our entire report for the record. We are appreciative 
of that.
    My primary focus today will be on the $50 billion threshold 
for the so-called bank SIFIs. Some of the discussion that we 
have heard already this morning focuses on that, but there are 
a number of issues that we think are critical here. I would 
just highlight that there are two that we think are 
particularly important: number one, to provide a greater 
flexibility, and to use that as a presumption and not as a hard 
line. And I think the flexibility here is particularly 
important.
    There are a number of issues that we have with the current 
$50 billion. Number one, and as you pointed out very clearly, 
Mr. Chairman, it is arbitrary. We remember the discussion of 
providing some separation between the very largest institutions 
so that we did not have a moral hazard issue, and that I think 
was significantly what allowed the Congress to decide to put it 
at $50 billion. It clearly includes institutions that are not 
systemically important, and I will come back briefly to that 
point in a minute.
    Number two, it only considers size, and size alone, and one 
of the things that has happened in the 5 years, I think, since 
the passage of Dodd-Frank is that we have learned a lot about 
how we can measure and evaluate systemic risk exposure.
    Importantly, it is not indexed. Fifty billion 5 years ago 
will be an increasingly small number relative to the banking 
industry and relative to the overall economy. And yet when it 
is in the statute, it is something the regulators cannot 
ignore.
    Importantly, it diverts scarce assets. This is true for the 
financial institutions, particularly the regional institutions 
that are most affected by it. But it is also true--and I feel 
very strongly about this point from the regulatory point of 
view. The bank examiners with the sophistication and the skill 
sets to be able to evaluate stress test, for example, or living 
wills are not a fungible commodity. There are not a lot of 
them. And it is very important that that group be focused on 
the institutions that are truly systemically important. And for 
those reasons, we are suggesting, number one, we are putting in 
a soft line, a $250 billion suggestion. We are not wedded to 
that. We just think it should be above the 50. But, very 
importantly, we think it should be a presumption as opposed to 
an absolute so that financial institutions who are at that size 
but not strategically important, as measured by the regulators, 
would not be--could be so recognized.
    Also, one other issue that we did talk about, Mr. Chairman, 
is that we had suggested that there would be--an idea that we 
think is worth pursuing is to have at least a task force 
looking at a trial run on consolidating the examination forces 
of the Federal regulatory agencies, and I could pursue that 
question if there is interest.
    Thank you.
    Chairman Shelby. Explain that.
    Mr. Olson. We are suggesting--in our report we included a 
recommendation that through the FFIEC there is a test plan to 
consolidate for examination purposes the examination forces of 
the Federal regulators, Federal banking industry regulators.
    Chairman Shelby. Professor Johnson.

   STATEMENT OF SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF 
        ENTREPRENEURSHIP, MIT SLOAN SCHOOL OF MANAGEMENT

    Mr. Johnson. Thank you, Senator.
    In the run-up to the crisis of 2007, the Federal Reserve 
did very badly. It had a great deal of discretion over how to 
watch for risks in the financial system, and it failed in those 
tasks almost completely with regard to not only the largest 
financial institutions in the country but also some of the 
medium-size firms, including National City Bank in Cleveland.
    As a result--and I think sensibly--Congress in the Dodd-
Frank Act gave some rather more specific instructions to the 
Fed to encourage them to focus their attention. This includes 
the issue which we are discussing today, Section 165(a)(1), 
which reads, ``The Board of Governors shall establish 
prudential standards,'' and then paragraph (a) says, that ``are 
more stringent,'' and that ``increase in stringency,'' based on 
some considerations that are specified later in the statute 
that include exactly the issues you discussed in your hearing 
last week and that have been foreshadowed here today: risk, 
complexity, derivatives, and so on.
    Now, I understand there is concern about this threshold of 
$50 billion, and I think that is a good discussion, and I think 
it is very good that you are holding the hearing, Senator. But 
I think if we are going to discuss numbers, we should be 
talking about exposures, risk exposures, total balance sheet 
size, which includes, of course, not just on-balance-sheet 
assets but also off-balance-sheet assets. Now, that includes 
different things for different banks. For some of the global 
megabanks, it is derivatives. Frankly, the derivative positions 
that some of these guys are carrying relative to their capital 
bases is very scary. I do not think that regional banks are in 
that kind of business, but they do have a risk exposure, a 
credit exposure, an asset size that is larger than just the 
stated asset number. The statute, I think unfortunately, has 
been interpreted as meaning only on-balance-sheet assets.
    So if you are going to talk about size, let us talk about 
exposures, and let us be careful in terms of how we define 
that. Obviously, if you are just going off to on-balance-sheet, 
what you are doing is creating an incentive for various kinds 
of financial firms to shift their business off balance sheet 
and to get around any kind of threshold or safeguard that you 
create in that way.
    Now, I have looked at the banks that would fall in the 50 
to 100--I really do not think you should go to $250 billion in 
terms of a limit. Bear Stearns, when it failed--remember, early 
2007?--had a balance sheet of under $400 billion. If you allow 
people with a balance sheet of 250, that is a risk exposure. I 
mean, I can take you through the banks in the 350 to 400 range. 
That is basically saying to the Fed, ``Eh, do not worry about 
the Bear Stearns-type category.'' I do not think that is the 
message you want to be sending to them.
    I have gone through and I put in my testimony in Section B 
if you look at all 10 of the bank holding companies that were 
between $50 and $100 billion in terms of total assets, at the 
end of 2013--and I did that because that is the last year for 
which we have the systemic risk reports that the Fed now 
requires. If you look at those 10, 4 of them actually had a 
total exposure--what I am talking about--over $100 billion. 
That is a substantial financial institution. Of the remaining 
six, two are subsidiaries of large non-U.S. banks that just 
failed the stress test administered by the Fed.
    Now, the foreign banks are not here to speak for themselves 
today. I understand that. I do not think they are lacking in 
resources to be able to handle the stresses. I mean, these are 
gargantuan organizations. They failed the stress test because 
they are not paying attention and they are not showing respect. 
So I do not think you want to let them out on their own.
    Of the remaining four, two of them had total exposure 
between $95 billion and $100 billion. That is pretty close to 
$100. So now we are talking about Huntington Bancshares in Ohio 
and Zions Bancorporation. Well, you probably saw the coverage 
in the Wall Street Journal on Monday about Zions Bancorporation 
and the very big gap in their understanding of risk between the 
view of the Fed. Now, that is a fascinating set of problems 
right there. So perhaps we are talking about moving Huntington 
Bancshares up to a different category, and that is an 
interesting discussion.
    Please, do not go back to the situation which we had before 
of just letting the Fed decide. Let the Fed have discretion. 
Let the Fed choose the criteria. The Fed did not get it right. 
On a bipartisan basis they did not get it right pre-2007. 
Please do not do that again. Please do not go to a limit of 
$250 billion. That will be ignoring the Bear Stearns-type 
problem.
    I think we should also recognize and hopefully discuss 
today variation within the regional bank models. I mean, in 
terms of the regional banks, the standard classification we are 
all using now, I guess, PNC and U.S. Bank are pretty 
substantial. They are as large relative to other banks as 
Continental Illinois was when it failed in the mid-1980s. And 
on the other end, we have banks like Huntington that are 
genuinely small banks and I think, you know, have a case for 
being regarded as being simpler and in some sense safer for 
themselves and safer for their shareholders. Their shareholders 
should be appreciative of the additional risk management 
measures that have been put in place as a result of Dodd-Frank.
    Thank you very much.
    Chairman Shelby. Thank you, Professor Johnson.
    I will direct my first two questions to Mr. Ireland and Mr. 
Olson. As I mentioned in my opening statement, a recent report 
by the Office of Financial Research, OFR, uses different 
quantitative criteria to determine whether a bank is 
systemically important. Do you agree that the criteria-based 
analysis cited in the OFR report is a more appropriate way to 
determine systemic risk than the current $50 billion asset 
threshold? Mr. Ireland?
    Mr. Ireland. Absolutely. The asset threshold, quite 
frankly, does not make any sense. The reason you rescue banks 
in various times is not because of their assets, but because of 
their liabilities and who they might threaten if they go down. 
It is not the asset size.
    Chairman Shelby. It is about their risks they take.
    Mr. Ireland. It is the risks they take and the risks that 
they are going to transmit to the rest of the economy. And the 
OFR criteria that are based on the Basel criteria look at those 
transmission channels and rate banks based on those 
transmission channels. I think that is a much more precise 
approach to dealing with the issue.
    Chairman Shelby. Governor?
    Mr. Olson. Mr. Chairman, I would agree, but I would put it 
in a slightly different context. It seems to me what the OFR 
new standards are is an example of some of the thinking and 
some of the tools that are now used to evaluate and measure 
risk exposures in a variety of ways that have happened since 
Dodd-Frank and since the passage of the bill and 165. So what 
we are seeing now, that is a good example, and there are a 
number of others, both of the U.S. regulators and international 
regulators, of how they have measured risk, although there is--
to take into consideration the complexity, for example, the 
substitutability, the suitability, and other factors like that 
that really determine what the risk exposure is.
    Chairman Shelby. I will tailor this question to Mr. Ireland 
and Mr. Smithy. Last week, we heard from the regulators here 
that they are tailoring Section 165 standards based on a bank's 
size. In your opinion--and start with Mr. Ireland and then Mr. 
Smithy--have the regulators ``tailored'' sufficiently to 
address differences in systemic risk here?
    Mr. Ireland. No. No. I think there are differences, and you 
see in the number of rules tiers where things become more--
requirements become more rigorous as you go up in size. But 
those differentiations are very crude, and I do not think they 
really reflect the differences in risk, particularly the scope 
of differences that you see outlined in that OFR report.
    Chairman Shelby. Mr. Smithy, do you have an opinion?
    Mr. Smithy. I would agree with Mr. Ireland that whereas the 
Fed has used efforts to tailor, it has been in one direction. 
It has been up. Again, they have used asset thresholds rather 
than always a range of practices. Range of practice would be 
more beneficial in determining how the risk should be tailored 
to the regulation.
    I would also say that the issue at its heart is that they 
cannot tailor down, i.e., a $51 billion bank has to be 
treated----
    Chairman Shelby. It is arbitrary, is it not?
    Mr. Smithy. It is. It has to be treated with higher 
prudential standards than a $49 billion bank even though the 
risks of those two institutions may be very similar.
    Chairman Shelby. Mr. Smithy, we have heard testimony that 
the regional bank model is simpler than that of the Nation's 
largest banks. The OFR study shows systemic risk scores that 
vary by a factor of over 125 ranging from 0.04 to 5.05. That is 
a good range there. Regions Bank scored 0.11 on the scale, 
which is about 2 percent of the systemic risk measure assigned 
to the highest scoring bank. Nonetheless, your bank is 
considered to be systemically important because it has more 
than $50 billion worth of assets, not necessarily because it is 
risky.
    Mr. Smithy. Right.
    Chairman Shelby. Please explain how your bank's business 
model differs from the Nation's largest banks and why that 
matters here.
    Mr. Smithy. Sure, Mr. Chairman. We are a very simple, 
straightforward business model. We take deposits and we focus 
on lending in our local communities.
    Chairman Shelby. Most of the regional and smaller banks, is 
that what they basically do?
    Mr. Smithy. Yes, sir.
    Chairman Shelby. OK.
    Mr. Smithy. And so what differs from our balance sheet and 
the risks inherent in our balance sheet versus some of the 
larger, more complex banks, the G-SIBs, is that we do not have 
complex trading activities. The largest single risk we take is 
credit risk. That is the risk we understand. We know how to 
manage it. We underwrite that every day. And we use our 
deposits, and 80 percent of the deposits--or, actually, almost 
90 percent of the deposits that we take in are used to fund 
lending activities; whereas, for some of the G-SIBs, that 
number is closer to 60 percent. Less than 1 percent of our 
balance sheet risk or the risk we take is related to broker-
dealer activities or derivatives activities; whereas, that 
number is closer to 20 percent for the G-SIB banks.
    Chairman Shelby. Governor Olson, according to your 
testimony, you spent a year and a half researching and 
assessing the effectiveness of Dodd-Frank, and one of the 
things that you concluded is that the $50 billion threshold is 
arbitrary. I think most people agree with that. Can you comment 
on how you reached that conclusion? And based on your 
experience--and you are a former Member of the Board of 
Governors of the Federal Reserve--would the regulators have 
sufficient information to assess whether a bank is systemically 
important if the $50 billion threshold were changed?
    Mr. Olson. Mr. Chairman, regarding the first part of your 
question, how we arrived at that, together with the sponsors 
that were working with us, Richard Neiman and I interviewed 
maybe 50 to 100, somewhere in that range, people representing 
academia, representing the financial community, many, many, 
many former regulators, representing of the consumer interests, 
and others, and focusing--our task force focused on the issue 
of architecture. And we found no advocates for maintaining the 
$50 billion threshold as a measure of when there is systemic 
risk. And so that was one of the first and easiest issues that 
we put forward.
    In fact, some of us old-timers who have been around a long 
time suggested that, back in the day, that probably would have 
been handled through a technical corrections bill following in 
the next Congress or two Congresses later because it did seem 
to us pretty obvious.
    To the second part of your question, the bank regulators 
have almost unlimited access to the banks themselves and have a 
lot of ability to look at risk exposures. For example, in 
relation to the previous comments that we heard here, for 
example, as early as 15 years ago when I was on the Fed Board, 
the bank regulators were looking at off-balance-sheet on a 
consolidated basis. So in terms of looking at capital adequacy 
and the measures of the manner in which they were looking at 
it, we had the ability to look at it very thoroughly.
    So the ability is there. What we are asking for now is the 
flexibility.
    Chairman Shelby. Governor, do you believe that raising the 
$50 billion threshold would hinder the Federal Reserve's 
ability to tier its supervisory regime?
    Mr. Olson. That raising it would hinder their ability? 
Raising it would not hinder.
    Chairman Shelby. Would not. You believe that in the $50 
billion threshold would hinder?
    Mr. Olson. No, I do not, Mr. Chairman, but I would like to 
add to that that we are also stressing that there ought to be 
an element of flexibility in terms of where that threshold is.
    Chairman Shelby. Thank you.
    Senator Brown?
    Senator Brown. Thank you. Interesting discussion.
    A question for you, Mr. Johnson. And, Mr. Smithy, thank you 
for joining us, and I have a couple questions for you.
    Professor Johnson, most people agree that Senate drafters 
of Dodd-Frank set the threshold at $50 billion because they 
wanted to avoid creating the moral hazard associated with a 
market perception that an institution is too big to fail. Is 
that an appropriate line to achieve that goal?
    Mr. Johnson. Yeah, I think that was a very good idea, 
Senator. The problem, for example, with the Basel Committee 
criteria that we are discussing that defined these--they 
currently have 30 G-SIBs, the global systemically important 
banks--is that this is the too-big-to-fail crowd. If that is 
the list that people in the market know have Government 
support, that is a very dangerous notion around the world. In 
the United States, we have a more diverse financial system. It 
was a good idea to have a threshold below, definitely below 
where the more intense too-big-to-fail issues are so you can 
look carefully--you do not have to spend all your resources on 
these mid-size banks, but you have to pay attention to them 
because, in particular, the interaction in some of these banks 
and some of the really big too-big-to-fail banks, that is where 
a lot of the damage happened last time and would happen again.
    Senator Brown. Implicit in that action would no one 
really--no one in the market really believes that Huntington or 
Regions or M&T are systemically such that they are too big to 
fail, that the Government would bail out, correct?
    Mr. Johnson. That is exactly my understanding, Senator, 
that if you take Huntington, for example--not to pick on them, 
but just as the name has come up--I do not think they are too 
big to fail. They are, however--they have, it is true, crossed 
this category where Congress asked the Fed to pay more 
attention, and the Fed is paying more attention. And I guess 
one of the banks in this category appreciate the attention.
    Senator Brown. Mr. Smithy, you mentioned M&T Bank's 
compliance costs. Tell me about Regions' compliance costs last 
year, and where do other members of your coalition of many 
banks, a dozen, a couple dozen, where do the other members of 
your coalition fall on that spectrum?
    Mr. Smithy. So, Senator, we mentioned in the testimony that 
for the group that we represent, there is greater than $2 
billion annual cost for compliance--or an increase of $2 
billion versus the period----
    Senator Brown. Spread over how many banks?
    Mr. Smithy. Spread over 20 banks. So M&T cites roughly a 
$400 million, a little over, cost for compliance. I would say 
Regions number is closer to $200 million, but, Senator, those 
are just the direct costs. And I think one of the more 
important elements of this are the indirect costs, which are 
management and the board's time and attention away from serving 
the needs of our customers and serving our communities as well 
as the enhanced supervisory standards create increases or 
higher capital levels and liquidity levels at that level, at 
the $50 billion level, that we must adhere to through CCAR and 
LCR, that frankly means there is less of those resources 
available for lending. And for a company like Regions, that 
standard being lifted would likely liberate as much as 10 
percent additional capacity for lending, which could be $8 to 
$10 billion.
    Senator Brown. OK. Thank you. That is helpful.
    We understand that in banking, or perhaps like in all 
things, time is money. I talked with Comptroller Curry last 
week about the fact--and had a number of conversations with 
him, private and public--tend to like--not to like business 
lines that do not bring in revenue, understandably, and 
compliance costs certainly are that. He spoke a lot about, you 
know, a risk officer and about someone, if--I think it is 
probably safe to say if Nat City in Cleveland had had a risk 
officer of the stature of some other leading bank officers and 
executives sitting at the table with similar compensation and 
similar authority and similar gravitas, Nat City would not have 
gotten in the problems it did, and while Nat City still 
survives inside PNC, it did great damage to the city I live in 
and many others in Ohio.
    I guess the point is that strong rules and risk management 
can ensure that practices that are profitable in the short term 
do not become harmful in the long term. I know you agree with 
that, but I think it is something important to emphasize.
    Let me more specifically, Mr. Smithy, ask you about some of 
the more onerous rules, what you think are the most onerous 
rules for Regions. Governor Tarullo emphasized stress testing 
as the biggest issue for regional banks. Which rules do you 
find are the most onerous? Speak specifically of your Alabama 
bank, if you will, not so much the coalition. So speak about 
the onerous rules for you, and then if you would, broaden that. 
Is that what your coalition banks would say, too? Is that true 
for your coalition members? Give us some very specific rules 
that cost you, that you think are onerous, that you think cost 
you too much.
    Mr. Smithy. So, Senator, at the $50 billion level, we are 
subject to enhanced standards, which, again, as I mentioned, 
includes stress tests, which frankly we think are a good idea. 
I will fully stipulate that pre-crisis the banking industry was 
in greater need of enhanced risk management practices and 
stronger internal modeling, stronger capital planning 
activities.
    I think the stress test that emanated from the original 
SCAP and have evolved into CCAR are a good thing. As a matter 
of fact, we built our whole entire capital planning process and 
strategic planning process around the stress testing framework.
    Where it becomes----
    Senator Brown. If I could interrupt for a moment, would the 
other 19 banks pretty much say what you said in your coalition 
about stress tests?
    Mr. Smithy. I think they would largely agree, yes.
    Senator Brown. OK. Proceed. Sorry.
    Mr. Smithy. Where it becomes more challenging or 
restrictive is, as part of the CCAR process, there is a stress 
test that the Fed conducts on banks, and there is an outcome 
from that stress test in terms of losses. And at the end of the 
day, our capital levels that we must manage to, despite what we 
calculate internally, the binding constraint becomes what the 
Fed calculates for us. And so one of the challenges--there are 
certain asset classes and products where the Fed sees risk just 
inherently higher than do the banks.
    A specific example would be commercial real estate, for 
example, and that is one that is--there is a much larger loss 
content for commercial real estate loans in the Fed's models 
than they are for bank models.
    So what does that mean? Well, that means that as a bank 
that must supply capital and liquidity to that business, A, we 
have to decide whether or not at that level of capital 
allocation it is worthwhile for us to be in those businesses, 
if we can make money in those businesses. And so the extent 
that that loss estimation, again, becomes our binding 
constraint, we have to decide whether or not--that we can 
allocate capital. And if we decide that we cannot and make 
money in that, then that activity gets increasingly pushed out 
of the regulated space and into the shadow bank market. And 
then one has to question whether or not the same level of 
needed liquidity will always be available.
    Another example that I would give you is around--I was 
recently in western Tennessee in our Memphis office meeting 
with a group of bankers that cover our Ag lenders, and they 
were citing that internal policies to match the cost of 
providing those services, liquidity and capital, were 
increasing the cost on Ag lenders, and that made for some very 
difficult conversation--excuse me, Ag borrowers, and it made 
for some very difficult conversations with those long-time 
customers.
    But, again, those are just some examples as to us being 
subjected to the internal stress test. Not only the test but 
the capital levels that come from that and the enhanced 
liquidity standards has a real cost to our customers, and it 
can affect whether or not we think we can be in those 
businesses strategically.
    Senator Brown. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    Last September, I asked Federal Reserve Governor Tarullo 
about increasing from $50 billion the current asset threshold 
for systemically important financial institutions, and he 
stated at that time that the Fed is open to considering a 
higher threshold ``up to the largest bank'' level. His answer 
reinforces my opinion that the $50 billion threshold is 
arbitrary and that Congress needs to determine a new threshold 
based upon the policy we intend to achieve.
    With the remaining time I have in this question segment, I 
would like to explore the merits of either increasing the 
threshold to the $250 billion level, which Mr. Olson supports, 
or using an activity test, which I understand you are 
proposing, Mr. Smithy. And so why don't we start with you, Mrs. 
Why would an activity test be a better metric to use to 
determine systemically important financial institutions than a 
numerical threshold?
    Mr. Smithy. Well, again, it is the arbitrary nature, 
Senator, of the numeric threshold that we oppose. We think the 
activity-based approach uses the data that the Fed has 
calculated and provides transparency as to what are the sources 
of risk that not only the institutions need to consider in 
managing, but also the regulators. It helps provide a road map 
for them in determining where they should divert their 
resources to make sure that their regulatory efforts are 
commensurate with where the risk is occurring in the economy.
    We do believe that ultimately there might be a correlation 
of size and those risk factors that above a certain size their 
size and risk seems to be more correlated. I am not sure 
exactly where to draw that line.
    Senator Crapo. That was going to be my next question.
    Mr. Smithy. But, again, I think you have the data and the 
OFR has the data. Now, we may argue about the elements of the 
data, and it may evolve over time. But you have the framework 
within which to determine where to draw the line if ultimately 
we do want to have an asset threshold.
    Senator Crapo. Well, thank you.
    Mr. Olson, could you comment on that and also explain how 
the Bipartisan Policy Center arrived at the $250 billion 
threshold as the best approach?
    Mr. Olson. Let me take the latter first.
    Senator Crapo. Sure.
    Mr. Olson. We emphasized that the $250 billion is a 
suggestion, and we got to that point because many of us have 
worked on legislation over the years and have seen legislation 
come together and think it is unlikely that Congress would make 
a change without putting a number in. So we put a number in 
that we thought would be high enough to isolate the very 
largest and most systemically important institutions while 
limiting the ones, particularly the regional banks, that do not 
have that same criteria.
    But we were quite clear that if there was a more 
appropriate number in there, we would be willing to go with 
that number, assuming also that there is some flexibility 
attached to it, so that it is a presumption as opposed to a 
hard line. And I think that is the real key, is making sure 
that you have that flexibility.
    I think below that number, you have got--and especially if 
it is a hard-line number, you have a phenomenon that we have 
seen in a number of cases where it distorts markets. In other 
words, financial institutions will fight to keep below that 
line, and once they cannot keep below it, they may make a large 
addition in order to become larger to spread out the additional 
overhead costs of being a so-called bank SIFI. And so the 
combination of those is what we had in mind.
    Senator Crapo. Well, thank you. And just to clarify, if we 
adopted any number, whether it be $250 billion or we stayed at 
the $50 billion, isn't it correct that the banks that would be 
exempt under that numeric threshold are still subject to safety 
and soundness regulation on very----
    Mr. Olson. Not only safety and soundness, but they could be 
designated as being covered as a bank SIFI by the--the 
regulators still have the option based on the activity test, as 
you suggested, they could be considered systemically important.
    Senator Crapo. So the real question we are trying to get at 
here is whether an institution is a risk to the system, not 
whether they should be exempt from regulation.
    Mr. Olson. That is correct. And just as a reminder, banks 
over $10 billion are required to have stress tests, and I will 
support Mr. Smithy on that comment. I think the advent of that 
kind of stress testing and any sort of a model that 
institutions are using has been a very important step forward 
in supervision.
    Senator Crapo. Thank you.
    Chairman Shelby. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman. Thank you for 
holding this hearing. And, you know, I agree with Mr. Olson. If 
we are going to be able to proceed on this, we need to find 
some bipartisan compromise to make sure we get it right, and I 
particularly appreciate the work of the Bipartisan Policy 
Center.
    I will start with you, Mr. Olson. And I agree that the $50 
billion number is a bit arbitrary, but wouldn't you concur--or 
what would you think if it was a $250 billion institution that 
had a great deal of geographic concentration? If that 
institution failed, while it might not bring down the national 
economy, it could have systemic effects at least on a regional 
basis, could it not?
    Mr. Olson. Concentration risk is a very significant risk, 
and it could be concentration geographically or concentration 
by loans. So, yes, very much so. We have seen in the Ag crisis 
and the oil crisis, we have seen times before where that issue 
was very important.
    Senator Warner. I agree with you on the notion that you 
want to have a line but not have it a hard-rule line, but 
oftentimes that is always a presumption going up and never a 
presumption coming down. How would we make sure that that 
presumption kind of ran in both directions?
    Mr. Olson. You would not--I think none of the Members of 
this Committee would be surprised, but it will come as no 
surprise to, I think, the Members of this Committee that the 
regulators pay a lot of attention to what the Congress thinks. 
And if the Congress makes a signal independent of the 
legislation, that will be heard and remembered.
    Senator Warner. Although I would simply point out that I 
think this Committee and all of us who were involved in 
carefully tried to draw a pretty firm line that said, 
particularly for smaller institutions, they ought to get a 
little more regulatory relief, and under the guise of best 
practices those practices have crept down even below the $10 
billion.
    Mr. Smithy, one of the things I have tried to get at, your 
concerns--what I hear more often from my regionals is sometimes 
less about actual capital standards or liquidity ratios, but 
actually just the cost of all the compliance, not so much the 
operating costs but just the costs of dealing with all the 
regulators. When you say that $200 million cost for your 
institution, can you break that out in terms of kind of actual 
personnel dealing with the regulators versus business costs, 
business model changes?
    Mr. Smithy. Well, a fair amount of that is increased 
spending on systems and technology. There are roughly 100 
people that work on, let us say, the CCAR process, which is one 
element of stress testing. There is another probably 10 or so 
that work on liquidity stress testing, and those are 
increasingly becoming more integrated. So there is certainly a 
direct cost from personnel.
    There is probably another 150 people around the 
organization that have a part in that process, but it is not 
their full-time job.
    So I would say that there is a lot of technology spend, a 
lot of models that have been built, infrastructure, the control 
environment. There is, you know, a quality program that we have 
put around the whole process to ensure that it is a properly 
controlled environment. And so there are many layers to that 
cost.
    Senator Warner. I guess what I am more--I am sympathetic to 
trying to cut down some of these layers, trying to cut down 
some of the compliance costs, but without sacrificing the 
standards. So let me go to you, Professor Johnson. Would you 
not see that there could be things we could do? For example, I 
think Mr. Olson's suggestion of a consolidated exam schedule is 
a great notion. But what I hear constantly from institutions is 
that they have got one set after another of regulators coming 
in, and that drives up the cost tremendously.
    You know, I really question in a plain-vanilla institution 
whether we ought to have--the living will process makes sense, 
but the idea that the living will process ought to be done 
repeatedly if you are not changing your business model? Are 
there other places where we might be able to give, even with 
your, I think, appropriate focus, daily liquidity capital ratio 
requirements that take a lot of time? I do not even think the 
regulators can look at it on a daily basis. But would you even 
as an advocate of tight reform be willing to look at areas 
where we might be able to drive down compliance costs but still 
keep appropriate prudential standards?
    Mr. Johnson. I think these are all good questions, Senator. 
I think the regulator has considerable discretion to tailor, 
and that is what they told you last Thursday. I read the 
transcript of that hearing fairly carefully, and I think 
consolidated examinations to some degree would be a good idea. 
Please do not forget that the FDIC's back-up examination 
authority has turned out in the past to be very useful as a 
safeguard, both for with regard to the system and also with 
regard to shareholders and creditors, and, of course, the 
Deposit Insurance Fund, which is on the hook when a lot of 
these smaller banks fail.
    So I think reducing compliance costs where it makes sense 
is sensible. I am very encouraged, though, by what Mr. Smithy 
said, and I think also what the Chairman said, which is 
Congress mandated some better risk management practices, and 
they have been adopted by many banks willingly, and they make 
very good use of them. And I do not think their shareholders 
would want to go back.
    So when we talk about the cost of compliance, I think we 
should also break out that part which is now best practice, as 
you called it, Mr. Chairman, and that part which you might 
regard as being a bit too much if you are $50 billion. Do you 
need to do a living will every year? That is a good question.
    If you get up to $200, $250, $300 billion, I think you 
should be paying very close attention. We have had some rather 
bad experiences with banks, both of that size in terms of 
nominal dollars and that size relative to the scale of the 
economy. You look at percent of GDP, what was Long Term Capital 
Management, what was Continental Illinois? It is exactly when 
you are getting up into that level, 150, 200, 300, that is when 
the Fed should be paying attention.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and I want to 
thank all of our witnesses for being here.
    Mr. Johnson, welcome back. I know you are gladly playing 
the skunk-at-the-party role here. It is good to have you here 
again.
    There has been a too-big-to-fail discussion here today that 
has been odd to me, and I would like to ask for a brief comment 
of all of the witnesses. I realize that people's memories fade, 
and over time things change, but over the next decade or so, 
let us say, if one of our larger institutions failed, is there 
any question that they would be--their equity would be wiped 
out, their boards would be wiped out, and their executives 
would be wiped out, their junior debt would be wiped out? Is 
there any question in your minds about that?
    Mr. Ireland. No. What happens in--
    Senator Corker. Well, that is good enough.
    [Laughter.]
    Mr. Smithy. No, Senator, not in my mind.
    Senator Corker. Well, why do we keep using that word? I 
find it misleading to the public and misleading in a debate 
when, in essence, they would be wiped out. So, Mr. Johnson, go 
ahead.
    Mr. Johnson. So, Senator, I am on the FDIC Systemic 
Resolution Advisory----
    Senator Corker. Is it yes or no, first?
    Mr. Johnson. The answer is no.
    Senator Corker. You do not think they would be wiped out?
    Mr. Johnson. Not necessarily. No, that is the problem, 
Senator. This problem is not over. Their probability they would 
be wiped out is higher. I will grant you that. Dodd-Frank has 
made some progress, yes.
    Is the answer to your question an unequivocal yes? 
Unfortunately not. That is a very, very big problem. I think it 
is a problem for the regional banks also because of spillover 
dangers from these, too big to fail could have on the regional 
banks that we should not want.
    Senator Corker. Yeah, well, what I find fascinating is all 
the regional banks use these words, ``too big to fail.'' I was 
with a group of them the other day, the 10 to 50s, and really 
was disappointed by their presentation. So they do not--they 
use these words, ``too big to fail.'' I disagree. I think if a 
large bank failed today, they would be in essence wiped out. 
Would their drive-in window still exist? Yes. Would their 
building still exist? Would their management be there? No. 
Would their equity be gone? Yes.
    So it is interesting. None of the regional banks want to be 
systemically important, and yet they keep using this pejorative 
term, ``too big to fail.'' So I would just like to understand--
not from you--where that is coming from.
    Mr. Smithy, can you share--I find that to be an odd place 
for people to be.
    Mr. Smithy. Well, Senator, as I stated, I do not think that 
too big to fail is indeed true in the context of whether or not 
management would be wiped out, equity of investors would be 
wiped out. I spend----
    Senator Corker. That is fairly painful, is it not?
    Mr. Smithy. That is the most painful thing that could 
happen, and as a Treasurer whose job is to ensure, you know, 
proper liquidity and capital for the institution, which is the 
lifeblood of the business, it is death of the business.
    Senator Corker. Let me just make a statement, and I know my 
time is going to run out. The way this debate all started, the 
ICBA came in and wrote a letter before we even had a bill, and 
they supported Dodd-Frank before Dodd-Frank existed, because 
basically what they thought was going to happen is they were 
going to get them, not us. They were going to get them, not us.
    And, obviously, what happens is over time the smaller 
institutions do get engulfed in all this, and that is what has 
happened, and certainly there are some things that need to be 
resolved, and I agree with that.
    I do think the $50 billion threshold that--look, one of the 
things that is most strange about serving in the Senate is you 
realize we just make this stuff up, right? I mean, somebody 
decided 1 day it was 50, and that is what it was.
    On the other hand, Mr. Ireland, I do have a degree of 
trepidation in punting again to the regulators. We did so much 
of that during Dodd-Frank, and so the qualitative piece is 
interesting to me. But I am not sure I want to punt again, I am 
sorry, especially not to FSOC, which I do not even really 
believe is functioning. I believe it is stovepipes of 
nothingness. It is not functioning the way that it should.
    So I have got concerns about that. Everybody obviously 
wants the level to be $10 billion above wherever they are, 
right? I mean, if you are at 50, you want it at 60. If you are 
thinking mergers and you are at 90, you want it at 120.
    So, I mean, everybody wants the number to be just above 
where they are and yet people keep using this too-big-to-fail 
piece, which, again, I find fascinating.
    I will remind people that TARP was spent on banks of 
varying sizes. That is a United States citizen risk when that 
occurs.
    So I would just close with this. I have got 16 seconds 
over. I am very open to making changes. I think we should make 
changes. What I am not interested in making changes is groups 
of people coming in saying, ``Get them, not us. We are not 
them.'' And this lobbying effort that is taking place, to me, 
is not healthy. To me, what we need is a healthy financial 
system, and I do not think we are focused on that right now. We 
are focused on groups of people who want relief, some of which 
is well deserved. And I think the 50 is too low. But I am more 
interested in making sure we have a stable financial system 
which creates--which means we have banks at all levels that are 
regulated properly. And I do not see that as being what is 
taking place here now.
    So, Mr. Chairman, I appreciate you helping illuminate that 
with this hearing, and I look forward to working with you.
    Chairman Shelby. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. Thank you all for 
being here today.
    After the financial crisis, Congress decided that the 
bigger banks should be subject to more oversight than the 
smaller banks. Congress drew the dividing line at $50 billion 
in assets, a threshold that left out all but about 40 of the 
6,500 banks in the country. And then after drawing that line, 
Congress explicitly gave the Fed the discretion to tailor how 
those standards applied among that small group so that the 
biggest and the smallest could be treated differently.
    Now, I know some people in the banking industry want to 
completely exclude even more banks from Dodd-Frank's stricter 
scrutiny, but the alternatives to the current $50 billion 
threshold raise a whole new set of problems.
    Professor Johnson, we have heard today one suggestion is to 
replace the $50 billion threshold with a multi-factor test so 
that the Fed would have to do an intensive study of every bank 
to determine whether they should be subject to higher standards 
or not. So I want to ask: Do you think that is a workable 
solution?
    Mr. Johnson. No, Senator. I think the Fed has a very bad 
track record in applying exactly that confused, multiple-
criteria set of issues. They could have done that before the 
crisis. They had a responsibility, clear legal responsibility 
to do it before the crisis, and they did not. So I do not think 
it is a good idea to ask them to do again what they previously 
failed to do spectacularly.
    Senator Warren. All right. Thank you. It seems like we have 
some evidence. We have tested that approach. And it seems like 
this particular proposal would require the Fed to spend a lot 
more time on an administrative task, leaving it a lot less time 
to spend on actually regulating and supervising the riskiest 
banks, which was exactly the point of Dodd-Frank.
    Now, the other proposal that has been talked about today is 
simply to raise the threshold to some higher number, like $100 
billion or $250 billion. And the main argument I hear in 
support of that is banks with about $50 billion in assets would 
not pose any systemic risk if they failed. I think that is what 
we have heard repeatedly today.
    You pointed out, Professor Johnson, that a $50 billion on-
book bank can actually be a $100 billion off-book bank, posing 
much higher risk, but I want to focus on another aspect.
    We learned or should have learned in the 2008 crisis that 
several banks can find themselves on the verge of failure at 
the same time. So, Professor Johnson, do you think it would 
pose a systemic threat if two or three banks with about $50 
billion on-book in assets were on the verge of failure?
    Mr. Johnson. Absolutely, Senator. In fact, the typical 
pattern of financial crises around the world--I used to be the 
chief economist at the International Monetary Fund. The typical 
pattern around the world is exactly what you talked about, 
which is you have some smaller financial institutions that are 
failing together, have very highly correlated portfolios, and 
then the thing starts to snowball and you bring down a really 
big financial player, one of the biggest banks in that market. 
Then you have got a full-blow financial crisis.
    So I think the scenario you are talking about is exactly 
typical experience of financial crisis always and everywhere.
    Senator Warren. So when we are talking about the risks that 
the $50 billion banks pose to the economy, we need to consider 
that not just one bank could go south at a time, but that two 
or three or four could be following similar business practices, 
get caught short at the same time, which would pose a much 
bigger risk to the economy. So it looks like to me we can use 
one of two approaches:
    We can draw the line somewhere, like $50 billion, and then 
rely on the Fed to use its discretion to tailor its supervision 
appropriately and to consider the risks that these banks may 
pose not only individually but also may pose together.
    Or we can raise the threshold number; we can cut loose all 
the banks that are smaller than $100 billion or $250 billion 
on-book, and who knows how much additional risk they have got 
off book, and hope that two or three of them do not make the 
same mistakes the way the banks did in 2008, when they nearly 
brought down the whole economy and had to be bailed out.
    You know, me? I would rather err on the side of being 
careful and covering a few banks that may not pose as much risk 
rather than running the risk of another crisis that plunges our 
economy back into recession. And since the American taxpayers 
are on the hook when the economy starts to implode, I suspect 
that most of them would prefer that Congress be careful as 
well.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Rounds.
    Senator Rounds. Thank you, Mr. Chairman.
    Mr. Olson, I have to share with you, I had 2 years in which 
we participated in activities at the Bipartisan Policy Center 
and the Governors Council, and I found the approach to be 
enlightening and I found it to be encouraging when we could 
come together and find ways in which on a bipartisan basis we 
could impact policy change at the national level. And listening 
to the testimony here among all of you, it has been 
enlightening to me today.
    I just want to just come up an analysis to begin with in 
terms of where I want to go with this, and then I would like 
your thoughts on this.
    The designation of a bank as systemically risky has a wider 
ripple effect across the economy as a whole, and I know that we 
are talking right now simply about the safety of the bank and 
about whether or not we could have a catastrophe on our hands 
if the banks were to fail. But last week, when we talked to the 
regulators, they were basically telling us that we did not have 
to worry and that they knew what they were doing when it came 
to regulating the banking industry.
    I think they were well intentioned. I think they really do 
believe that they have things under control. But what I want to 
know is when we talk about their decisions and the impact they 
have not just on the banks but on the economy as a whole and 
how it affects the borrowers and access to credit, to me their 
answers were troubling, because it seemed as though we were 
looking at this in a vacuum.
    I think the regulatory decisions they make do not just 
occur in that vacuum and that they have a real effect on real 
people that need access to capital and credit.
    For example, when a bank is forced to hire more compliance 
officers or retain more capital, it makes fewer loans. And I 
think that is what Mr. Smithy is suggesting. This means that 
there is less money available for small business owners to 
start and expand businesses.
    If we take a look at what is happening to our economy since 
the beginning of a recovery and what appears to be not a robust 
recovery, I wonder whether or not a lot of that has to do with 
literally a regulatory hand on the top of the ball which is 
sitting in the water, holding it down from where it would 
otherwise be.
    So, with that, I am just curious, because, Mr. Smithy, you 
have talked about the impact that it has had on your bank, but 
from 2009 to 2013, your risk management expenses, I believe 
under your testimony, you indicated that it had doubled. Now 
you have indicated that your costs are somewhere around $200 
million.
    But what did it do to your ability to make loans? I mean, I 
think there is an impact there. Would you care to share a 
little bit about what the impact has been on your bank's 
ability to make loans?
    Mr. Smithy. Sure. I would add one other stat that is very 
interesting. We now have more people in our organization 
devoted to compliance-related matters than we do for commercial 
lending.
    Senator Rounds. As a matter of fact, I think across the 
financial institution world, right now we are talking about 
since 2009, I think the number I heard was 300,000 more people 
employed in financial services, and it is in compliance is 
where they are at rather than in the production side of things.
    Mr. Smithy. And, again, Senator, I would stipulate that we 
have learned a lot through the process. We are better at 
understanding the risks we take. It is better controlled. We 
have better concentration risk management practices in place. 
There has been, you know, modeling enhancements that have come 
out of the crisis and the stress testing framework that I would 
submit helps us make better decisions. But at the end of the 
day, it is the fact that we have to keep capital and liquidity 
in surplus to guard against risks that we think are remote, and 
that is capital and liquidity that cannot be used to make those 
loans, you are suggesting.
    Senator Rounds. I think there seems to be a sense that $50 
billion was arbitrary and that it is a matter of trying to find 
the right number. But also we have heard testimony today that 
it should be based upon the activity that is being involved, 
and that would be perhaps a better model.
    But, Mr. Olson, I am curious. Under the proposal that have 
looked at, how do we know that if we allow more of an 
opportunity for the regulator to make those decisions that we 
do not end up with a regulatory process which is even more 
challenging with regard to trying to figure out what the 
regulator is going to want this year versus next year versus 
the following year? And just how much tether should we have on 
a regulator to make those demands upon the banking industry or 
the individual banks that they are looking at?
    Mr. Olson. A very important fundamental question, Senator. 
And having been on both sides, having been a banker and having 
been a bank regulator, being a banker, among other places, in 
Fergus Falls, Minnesota, and being a bank regulator with the 
Fed, one thing that becomes very clear when you become a 
regulator is that Congress has given a very specific mandate to 
the regulators. Your responsibility is the financial 
institutions' safety and soundness and compliance with laws and 
regulations. That is the rule.
    So the balance between what is the appropriate regulatory 
regime and legal regime is the responsibility of the 
policymakers, which is the Congress. That to me is why we are 
having--why it is important to have hearings like this, 
especially in light of a major piece of legislation, much of 
which is supported by the Bipartisan Policy group in terms of 
its overall effect. But looking at that balance is really key.
    Senator Rounds. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Scott.
    Senator Scott. Thank you, Mr. Chairman. Thank you for those 
serving on the panel this morning giving us an opportunity to 
have insight into your perspective. I certainly appreciate the 
academic perspective of Professor Johnson on the impact of this 
new regulatory environment.
    I, on the other hand, am a small business owner, and so for 
me, I look at the perspective of how all this comes down to the 
end user, the person, Mr. Smithy, who comes into your bank 
looking for a loan. In South Carolina, I think you guys have 
about $1.2 billion of outstanding loans. What that means to me 
is that the ability for small business owners to invest, to 
innovate, and, more importantly, to create jobs is visible 
through the number of dollars in outstanding loans to small 
business owners in my State who are better prepared to make 
sure that our economy continues to grow. And I am a believer 
that we need to have responsible regulations. My thought is 
that we do not need to have irresponsible levels of 
regulations. I am on the Finance Committee as well, so I have 
headaches many days of the week.
    But I will suggest to you, as I did to Governor Tarullo, 
that the Basel and Dodd-Frank standards that come with the SIFI 
designation is like a tax on labor and capital, and that tax 
has a dynamic negative growth effect on our economy. And you 
have said it a number of ways, Senator Rounds, I think Senator 
Warner asked a similar question. And my question really goes to 
the impact on small business owners like myself in this 
climate. You said that there were approximately--your 
compliance costs were a little over $200 million. You have 150 
compliance officers. And then your last comment was not 
shocking, but it should be shocking, I think, to those who are 
not familiar with the impact of the Dodd-Frank regulatory 
environment. You now have as many folks working on the 
regulatory side as you do on the lending side. That suggests to 
me that perhaps the climate that you are working in is not 
conducive for actually having an impact on the economy through 
lending money. You are almost a company that now exists to a 
large extent for providing a conversation with the compliance 
officers. That does not make a lot of sense to me.
    Mr. Smithy. Well, obviously we would agree. I think we, 
too, are supportive of banking practices that promote stability 
in the communities that we serve and give us an opportunity to 
serve those customers and the communities' needs.
    I think, again, we would fully stipulate that there has 
been a lot of improvement in internal practices, what might be 
deemed as compliance but are risk management practices that 
help us better serve the customer.
    What I would say, though, is being deemed systemically 
important adds another layer of cost and oversight to that 
process that we think is not commensurate with the risk that we 
pose to the system, and so, therefore, it inhibits our ability 
to, as you say, focus on innovation, focus on technology, and 
focus on serving the needs of those customers. I would agree 
with you.
    Senator Scott. Mr. Smithy, I do appreciate the fact that 
one of your opening comments was the fact that it was important 
for the stress test and the opportunity to make sure that you 
are safe and sound, those were important characteristics moving 
into the regulatory conversation. So I really appreciate the 
fact that you are not suggesting that there should be no 
regulations or that even enhanced regulation has not been 
beneficial to the industry. But the fact of the matter is that 
there has to be some threshold where it makes sense. Is that an 
accurate statement?
    Mr. Smithy. That is a fair assessment.
    Senator Scott. Mr. Ireland, I see you shaking your head 
over there a little bit, and I will tell you that, to me, right 
now the SIFI threshold is too low, it appears, and we are 
making regional banks act like and think like and hire like it 
is a G-SIB. It is a large bank with operations that are so 
complex and so interconnected that the oversight, the enhanced 
oversight is absolutely necessary and that there is really no 
impact on the economy or on consumers. That just seems to fly 
in the face of reality. I assume that is a part of the----
    Mr. Ireland. I think that is right. I think, you know, as 
attractive as thresholds may be as a legislative solution, they 
are not consistent with practices, and the banking models are 
very, very different The risks they pose to the economy are 
very, very different, and they need to be treated accordingly 
to avoid creating what economists will often call ``dead 
costs,'' which are compliance costs that do not reduce risk, 
that are merely there for compliance purposes and do not foster 
better banking.
    Senator Scott. Let me use my last 13 seconds for Mr. Olson, 
because you just hit the nail on the head, which is the dead 
costs. We have finite resources available without any question. 
And so from my perspective, I would love to hear--as a former 
official at a bank, a regulatory agency, can you comment on why 
it is important for regulatory efficiency that we have a more 
meaningful way of figuring out where not to waste these very 
limited resources?
    Mr. Olson. Senator, that is a good question. It is the 
inverse of the squeaky wheel gets the oil. What we should be 
doing is concentrating these finite resources where the real 
risk exposures are. Right now all the wheels are getting the 
same amount of oil in a significant way, and there is a 
limitation, and I will defer to my former colleague Ollie 
Ireland in terms of in his testimony where he said that 
tailoring alone cannot address this issue. It will take a 
change in legislation. And he is better qualified to address 
that than I am, as I am not a lawyer. And so putting the 
resources in the right place is important.
    I would also like to add that I have, as a former banker 
and a regulator, tremendous respect for the people who are now 
the examiners in the field. If I can have 20 seconds, Mr. 
Chair, I would just say that one of my burning memories is an 
examiner coming to me and pointing out one of the most highly 
respected people in our community, and he brought in the file, 
and he said, ``This person is going to fail.'' And I said, ``No 
way. I know him too well, and I am too good a banker. He is not 
going to fail.''
    Well, I do not have to tell you what happened. He failed. 
And I have never--that has been a lesson to me on the 
importance of getting the input from the regulator examiners 
that can spot anomalies.
    Senator Scott. Yes.
    Mr. Olson. Which is what the regulators do best. Thank you.
    Senator Scott. Thank you, Mr. Olson.
    Thank you, Mr. Chairman, for the extra time.
    Chairman Shelby. Thank you, Senator Scott.
    Mr. Ireland, in your testimony you stated that the Fed 
``can establish asset thresholds above $50 billion for the 
application of some, but not all, of these enhanced prudential 
standards.'' Could you clarify where the Fed is limited by 
statute to tailor Section 165 regulations? Just for the record.
    Mr. Ireland. 165(a)(2)(B), asset threshold for application 
of certain standards, ``The Board of Governors may, pursuant to 
recommendation by the Council''--this is the FSOC Council--``in 
accordance with section 115, establish an asset threshold above 
$50 billion for the application of any standard established 
under subsections (c) through (g).'', which omits subsection 
(b), which specifies a number of standards. And so the $50 
billion threshold for the (b) standards, which include risk-
based capital, liquidity, overall risk management, resolution 
plan, concentration limits, and so on, are tied expressly to 
the $50 billion threshold.
    Chairman Shelby. Thank you.
    Mr. Olson, in your written testimony, you recommend 
indexing the $50 billion threshold in Dodd-Frank to economic 
growth or a similar metric. Last week, Fed Governor Tarullo 
right here indicated that he would support indexing the 
thresholds set in Dodd-Frank. Why do you think it is important 
to index with Dodd-Frank?
    Mr. Olson. Senator, as the economy grows and as times 
change, and particularly with the impact of inflation, what is 
a $50 billion threshold in 2010 will be a fraction of that in 
2030. And yet the threshold should move in concert with some 
other metric.
    We are suggesting the metric being the size of the economy. 
It could be GDP. It could be the size of the banking industry 
or the financial services sector, but it is important that it 
be indexed.
    Chairman Shelby. Mr. Smithy, it is my understanding--and 
correct me if I am wrong on this--that when assessing systemic 
risk, the OFR-described methodology looks at the banks' 
interconnectedness as one of the factors which ought to address 
the concerns of several smaller banks bringing the system down. 
Are you familiar with that? Is that right?
    Mr. Smithy. Yes, I am, Mr. Chairman.
    Chairman Shelby. Is this correct?
    Mr. Smithy. That is correct.
    Chairman Shelby. Thank you.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    Dr. Johnson, I have long believed, as I know you have, and 
I have heard the Chairman speak about it often, that banks need 
more and better quality capital, that much of what happened to 
the bank in my city, National City, and banks all over the 
country, if they had been better capitalized, the problems 
would have been less severe.
    Mr. Smithy said--and I appreciated your comments in 
response to my question earlier--that Dodd-Frank is not 
flexible enough because it does not relieve banks from capital 
and liquidity rules, and that capital and liquidity, therefore, 
insufficient capital and liquidity, if you will, inhibit 
lending.
    Respond to that, if you would, Professor Johnson, on his 
comments about capital and liquidity and what it means for his 
bank. And if you would also tell us--answer a couple more 
questions. Are regional banks subject to any capital rules 
other than Basel III? And are these rules appropriate for these 
banks? If you would take all three of those.
    Mr. Johnson. I think Mr. Smithy should speak about his 
bank, but in terms of the general pattern of the rules and the 
tiering of the system and also, I think, very much this is 
about the flexibility of the Federal Reserve, Basel III is an 
international agreement that sets some floors, and then the Fed 
has chosen how to build on top of that. And they absolutely 
have focused their attention on the largest, most complex, most 
interconnected financial institutions, which makes a lot of 
sense.
    Now, the capital requirements are higher than they used to 
be across the board above some minimum size, and that also 
seems appropriate, Senator. In fact, I rather like the Brown-
Vitter legislation that would set an even higher and more 
demanding capital requirement with a step up at $50 billion, I 
believe, and another step up at $500 billion in terms of total 
assets.
    So I think that the capital requirements and the way they 
are being applied are appropriate. I think they are appropriate 
for the regional banks. The Fed has--and other regulators, but 
the Fed is in the lead here--a lot of flexibility in terms of 
how it applies them, and I do not think that they are too high. 
If anything, they are too low.
    Senator Brown. Thank you. A question about stress tests for 
Mr. Olson and Mr. Ireland and Professor Johnson. Yesterday's 
Wall Street Journal had a story that was cited earlier about 
Zions disagreement with the Fed about how much value their CDOs 
would lose in a financial crisis. Zions says the number is 
zero; the Fed says the number is 400. Mr. Olson, starting with 
you, and then--I am sorry, Mr. Ireland, then Mr. Olson, then 
Professor Johnson. If the Fed and the bank disagree on risk, 
who should win that argument?
    Mr. Ireland. Ultimately, the Fed has to win that argument.
    Senator Brown. Governor Olson?
    Mr. Olson. The Fed will win that argument without----
    Senator Brown. The question was: Who should win that 
argument?
    Mr. Olson. And I am not at all familiar with the individual 
circumstance of the individual bank other than what I read. But 
at the end of the day, the regulator will prevail in a stress 
test.
    Senator Brown. OK. I asked who should win the argument, not 
who will win the argument.
    Mr. Olson. It should be a balance, actually, because there 
are--the stress tests are--all of the stress tests have a 
certain amount of assumptions in them. So you have to go back, 
and you have to look at each of the assumptions, and it is the 
responsibility of the bank to defend all of the assumptions 
that they have made in that test procedure.
    And so it needs to be an ongoing dialogue. It cannot just 
be an up-or-down.
    Senator Brown. Professor Johnson?
    Mr. Johnson. Well, my colleagues have been very positive 
about the Fed and the Fed judgment when talking about setting 
criteria and so on. I am a bit more skeptical of the Fed's 
judgment. But my skepticism is a little one-sided. I think what 
we have seen based on that track record over the past, let us 
say, 20 years is they have tended to defer too much to industry 
assessments, and they have tended to understate losses. There 
are not that many instances we have seen where the Fed has got 
it wrong exaggerating how bad things are going to be. If 
anything, they tend to downplay the potential losses.
    So I thought that article was really very interesting, and 
I think that is a big flag for anyone involved with Zions. The 
Fed is saying this on the basis of information and data and 
experience, and the Fed does not tend to over exaggerate the 
losses in these kinds of situations. Their bias has rather, 
unfortunately, historically been to defer to the industry.
    Senator Brown. Governor, do you want to speak to that?
    Mr. Olson. Yeah. Senator, I respectfully disagree. Having 
been on the other side of that table and having been on the 
side of the regulator listening for the 5 years that I was on 
the Fed Board, the banks telling us that we are too strict and 
too hard on them, his statement is clearly an overstatement.
    Mr. Johnson. Senator, then how do we explain what happened 
in the run-up to 2007, the massive losses across the board in 
the financial system and the collapse of National City Bank, 
among other things?
    Senator Brown. Governor Olson was there right before that 
happened, my understanding, 2006.
    Two more questions. Mr. Ireland, I thought I heard you say 
the Fed cannot lift the threshold of living wills. Is that 
correct? Is that what you said?
    Mr. Ireland. I think the--I read to you from the statutory 
language. I find the statutory language a little bit confusing 
myself, but one of the listed criteria or requirements in 
subsection (B) which is not accepted is resolution plans. And 
so it appears that they cannot lift the resolution plans if 
they are adhering to that statutory language.
    Senator Brown. Professor Johnson, I have one other, but go 
ahead.
    Mr. Johnson. The regulators have said quite clearly, 
including last week, that they can tailor resolution planning 
to a very, very large degree. The one statutory constraint that 
they feel binding is on the stress test, and participation in 
the stress testing starts at $10 billion, as we have discussed, 
on an annual basis run by the firms. But the semiannual stress 
testing at the firm level and the annual CCAR, that is a $50 
billion requirement right now.
    Senator Brown. Last question, Mr. Chairman, and thank you 
for your indulgence.
    Both Governor Olson and Mr. Ireland said that raising the 
threshold or eliminating it entirely would conserve regulators' 
scarce resources. I hear that argument a lot with community 
banks. I generally believe it. Simplifying the larger banks so 
that they are no longer too big to regulate would also, I think 
it goes without saying, help agencies better allocate their 
resources. So my last question, Professor Johnson: Do you think 
that regulators, regional banks, and taxpayers would benefit 
from the proposal that I offered sometime ago, the Brown-
Kaufman bill--Senator Shelby supported it as an amendment on 
the Senate floor; Governor Tarullo has spoken out about it--to 
cap banks' nondeposit liabilities at 3 percent of GDP? Would 
that make the situation better?
    Mr. Johnson. Senator, that would help on a number of 
dimensions, including enabling regulators to do a better job, 
but also reducing systemic risk as being measured by--you are 
all talking about the OFR report. Well, the OFR report, I think 
you should look at those levels of systemic risk that got 
around the biggest financial institutions. Those are very 
scary, Senator, and your Safe Banking Act would exactly address 
that issue in an indexed fashion, indexing the size of the 
largest banks to 3 percent of GDP.
    Senator Brown. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Olson, I noticed recently that some of 
our largest banks had some trouble meeting their capital 
standards in the stress test. Did the regional banks overall--
maybe I should ask Mr. Smithy this question. Did they have 
trouble like our biggest banks barely getting over the line on 
some of the capital and stress test? Mr. Olson, you first.
    Mr. Olson. Mr. Chairman, I apologize. I do not have that 
information in front of me, so I am not able to answer.
    Chairman Shelby. OK. Mr. Smithy?
    Mr. Smithy. The regional banks did not face as many 
obstacles, if you will, in meeting their objectives.
    Chairman Shelby. OK. Do you know of any regional banks 
that--well, ``any'' is a big word--that failed their test?
    Mr. Smithy. Not to my knowledge this year.
    Mr. Johnson. Excuse me?
    Chairman Shelby. Do you know, Professor?
    Mr. Johnson. Yes, Senator. I am just looking at--using the 
definition of ``regional banks'' from Mr. Smithy's testimony, 
and Santander did fail their test. Santander is on the list; 
they did fail their stress test this year. And we have, of 
course, also been discussing the situation with Zions, which is 
also on the list, that barely passed the stress test.
    Chairman Shelby. You know, you have heard it said--and it 
was said here I believe by Dr. Volcker, and I will paraphrase 
him--that if you are too big to fail and you are too big to 
regulate, maybe you are too big to exist. A lot of people have 
that feeling, I believe, in America.
    I thank all of you for your testimony today.
    Mr. Johnson. Thank you.
    Mr. Smithy. Thank you.
    Mr. Olson. Thank you.
    Chairman Shelby. The Committee is adjourned.
    [Whereupon, at 11:37 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follows:]
                PREPARED STATEMENT OF OLIVER I. IRELAND
                      Partner, Morrison & Foerster
                             March 24, 2015
    Chairman Shelby, Ranking Member Brown and Members of the Committee, 
it is an honor to be here today. My name is Oliver Ireland, and I am a 
partner in the Financial Services practice at Morrison & Foerster here 
in Washington, DC. I have worked for over 40 years as a financial 
services lawyer. I spent 26 of those years in the Federal Reserve 
System, including over 10 years in the Federal Reserve Banks and 
fifteen years as an Associate General Counsel at the Board of Governors 
of the Federal Reserve System (``Board'') in Washington. As an 
Associate General Counsel, I helped establish policies and write rules 
designed to reduce systemic risk in the financial system and rules to 
foster consumer protection. During my tenure at the Federal Reserve, I 
was involved in a number of significant economic events, including the 
Chrysler ``bailout'' in 1980 and 1981, the Continental Illinois 
National Bank and Trust Company (``Continental Illinois'') ``bailout'' 
in 1984, the Ohio and Maryland thrift crises in 1985, the 
recapitalization of the Farm Credit System in 1986 and the savings and 
loan crisis of the late 1980s and the early 1990s. As a private-sector 
attorney for the past 14 years, I have had the opportunity to work 
directly with financial institutions as they struggled to cope with the 
most recent financial crisis and adapt to the new standards and rules 
that have flowed from the Dodd-Frank Act.
    The Dodd-Frank Act contains significant reforms that are designed 
to stabilize and improve the functioning of our financial institutions, 
financial markets and the markets for financial products and services. 
These reforms have been supplemented by changes in capital requirements 
under Basel III. A key focus of these efforts has been to eliminate the 
phenomenon of financial institutions that are too big to fail. These 
institutions must be ``bailed out'' in times of trouble by the Federal 
Government in order to prevent ``systemic'' problems in the financial 
system. Historically, Federal Government intervention in support of 
private-sector financial institutions has been limited. In the recent 
financial crisis, the Federal Government's actions may be more properly 
characterized as attempts to stabilize markets as opposed to bailouts 
of individual institutions. However, individuals often have a negative, 
visceral reaction to bailouts because they perceive them to be unfair, 
and policymakers understand that bailouts can create a moral hazard 
that erodes private market discipline.
    The origin of the term ``too big to fail'' is sometimes traced to 
the rescue of Continental Illinois in 1984 by the Federal Deposit 
Insurance Corporation (``FDIC''). At the time, Continental Illinois was 
the 8th largest bank in the United States. In congressional testimony 
later that year, the Comptroller of the Currency, Todd Conover, 
suggested that there were 11 banks in the United States that could not 
be allowed to fail.
    The potential for market events, including bank failures, to have a 
destabilizing effect has been recognized since at least 1873 when 
Walter Bagehot discussed the characteristics of money markets in 
Lombard Street. Although it is an over-simplification, there are 
generally two flavors of ``systemic'' risk-knock-on, or domino, risk 
and panic risk. Domino risk arises when the failure of one institution 
triggers the failures of other institutions due to their credit 
exposure to the failing institution. Panic risk occurs when the failure 
of a financial institution or other event causes a loss of confidence 
in financial institutions or assets. As a result, liquidity dries up 
and asset prices decline due to a lack of buyers. This, in turn, 
triggers widespread failures that further depress confidence, creating 
the potential for a downward spiral of increasing scope and severity.
    The Continental Illinois bailout has been cited as an example of 
domino risk. The FDIC in a study described the risks posed by the 
failure of Continental Illinois as follows:

        With regard to Continental Illinois, the regulators' greatest 
        concern was systemic risk, and therefore handling Continental 
        through a payoff and liquidation was simply not considered a 
        viable option. Continental had an extensive network of 
        correspondent banks, almost 2,300 of which had funds invested 
        in Continental; more than 42 percent of those banks had 
        invested funds in excess of $100,000, with a total investment 
        of almost $6 billion. The FDIC determined that 66 of these 
        banks, with total assets of almost $5 billion, had more than 
        100 percent of their equity capital invested in Continental and 
        that an additional 113 banks with total assets of more than $12 
        billion had between 50 and 100 percent of their equity capital 
        invested.\1\
---------------------------------------------------------------------------
    \1\ FDIC, An Examination of the Banking Crises of the 1980s and 
Early 1990s, 250 (1997).

---------------------------------------------------------------------------
        In Lombard Street, Walter Bagehot discussed panics as follows:

        When reduced to abstract principle, the subject comes to this. 
        An `alarm' is an opinion that the money of certain persons will 
        not pay their creditors when those creditors want to be paid. 
        If possible, that alarm is best met by enabling those persons 
        to pay their creditors to the very moment. For this purpose 
        only a little money is wanted. If that alarm is not so met, it 
        aggravates into a panic, which is an opinion that most people, 
        or very many people, will not pay their creditors; and this too 
        can only be met by enabling all those persons to pay what they 
        owe, which takes a great deal of money. No one has enough 
        money, or anything like enough, but the holders of the bank 
        reserve.

         . . .

        If all those creditors demand all that money at once, they 
        cannot have it, for that which their debtors have used, is for 
        the time employed, and not to be obtained. With the advantages 
        of credit we must take the disadvantages too; but to lessen 
        them as much as we can . . . \2\
---------------------------------------------------------------------------
    \2\ Walter Bagehot, Lombard Street, 44 and 46 (1873) (emphasis 
added).

    Domino risk and panic risk are not necessarily independent of each 
other. For example, domino risk can itself create or feed a panic. 
While the failure of other types of institutions can create systemic 
problems and past bailouts have not been limited to banking 
institutions, banking institutions are particularly susceptible to both 
forms of systemic risk. This is true because of the very nature and 
core business of banks. Banking institutions borrow short-term from 
depositors and other creditors to fund long-term assets. This creates a 
maturity mismatch that can lead to liquidity shortfalls and deposit 
runs. In turn, these liquidity crunches lead to fire sales of assets at 
distressed prices, which erode bank capital and confidence in banks. 
Depositors and other creditors who lend to banks bear the credit risk 
that can lead to a domino effect and banks' hard to value loan assets 
and maturity transformation activities create the potential for a loss 
of confidence and panic risk.
    For these reasons, banking institutions have been the focus of 
prudential regulation at the Federal level in the United States for 
over 150 years. Over time, this regulation has been refined to account 
for the size and complexity of banking organizations; however, the 
recent financial crisis revealed serious shortcomings in the existing 
regime. The Federal Government had to intervene to recapitalize large 
and some small banking institutions, as well as a number of nonbanking 
institutions. The Dodd-Frank Act represents, in part, an effort to 
avoid similar bailouts in the future, but there is no simple solution 
for the too big to fail quandary.
    Macroeconomic stability is a key goal of prudential regulation. The 
economic and human consequences of the recent financial crisis and 
prior financial crises have been enormous, resulting in devastation 
that can last for years or even generations. Simply refusing to 
intervene to stabilize the financial system during a financial crisis 
may not be an acceptable policy choice. At the same time, short-term 
fixes to prevent or contain an economic meltdown, such as a bailout, 
can diminish market discipline and increase risk taking by individual 
institutions and their counterparties. This erosion of market 
discipline, or moral hazard, can itself lead to future crises. Ideally, 
we should foster robust financial institutions and encourage prudent 
risk taking that reduces the likelihood of future stress and, at the 
same time, increases financial institutions' ability to withstand the 
stresses that do arise.
    At the same time, financial intermediation, and particularly the 
extension of credit, is inherently risky. These risks can be mitigated 
but they cannot be eliminated. To a certain extent, risk taking 
behavior is beneficial, because it fosters the innovation and economic 
growth that maximize employment and increase standards of living. There 
are serious consequences to unnecessarily increasing the costs of 
financial intermediation or constricting the availability of credit and 
other financial services that would otherwise be available in a fair 
and efficiently functioning market.
    Legislators and regulators have attempted to balance these 
considerations for some time, but a proper equilibrium has proved 
elusive so far. Dodd-Frank, which was shaped by the experiences of the 
recent financial crisis, is an effort to recalibrate with a distinct 
focus on reducing the potential for individual institutions to create 
systemic problems. One of the main tools in Dodd-Frank that will be 
used to address systemic risk is the prudential standards for bank 
holding companies with total consolidated assets of greater than $50 
billion established under Section 165. These standards are meant to 
increase in stringency based on a list of specified factors and other 
risk-related factors that the Board will consider. In establishing 
these standards, the Board can differentiate among companies based on 
their size, complexity and other factors, and, pursuant to 
recommendations of the Financial Stability Oversight Council, the Board 
can establish assets thresholds above $50 billion for the application 
of some, but not all, of these enhanced prudential standards.
    Section 165 is clearly designed to apply to large, interconnected 
banking organizations whose failure could threaten the financial 
stability of the United States. While Section 165 allows for some 
flexibility, the $50 billion assets threshold is its most specific 
differentiator. Other provisions of Dodd-Frank, and other aspects of 
existing and new regulatory requirements, including, for example, the 
Volcker Rule and the requirement to use the advanced approaches method 
in capital calculations, also provide for varying standards based on 
thresholds tied to the size of the institution or the size of the 
activity.
    Without a doubt, the overall size of a banking institution is a 
factor in the likelihood that such an institution could pose a risk to 
the financial stability of the United States. But supervisors globally 
have increasingly focused on a broader, more nuanced array of systemic 
risk measurements. They have begun to weight these measures in order to 
tailor supervisory policies to the activities most likely to affect 
financial stability. For example, in July 2013, the Basel Committee on 
Banking Supervision (``BCBS''), which consists of representatives from 
over two dozen of the world's most economically significant countries, 
presented five principal factors for identifying global systemically 
important banking organizations. These factors include size, which for 
purposes of the BCBS calculations is a measure of total exposures as 
opposed to total consolidated assets, interconnectedness, 
substitutability, cross-jurisdictional activity and complexity. The 
factors other than size are subdivided into component factors and the 
factors and component factors are weighted. Scores are calculated for 
each factor by dividing the individual bank score for that factor by 
the aggregate score, which is the sum of the scores of the 75 largest 
global banks plus selected additional banks.
    Since the factor on cross-jurisdictional activity was included by 
the BCBS to measure global risks, it is likely that it is less 
significant for purposes of measuring systemic risks to the U.S. 
economy. The other BCBS systemic risk factors, coupled with a similar 
measurement process that is tailored to the U.S. economy, could be used 
to identify banking organizations that pose systemic risks to the 
United States. The U.S.-focused scores could then be used by the Board 
to refine regulatory requirements for and supervisory scrutiny of those 
institutions. The Board already collects the necessary data on the BCBS 
factors from bank holding companies with total consolidated assets of 
$50 billion or more.
    Such a tailored approach in the implementation of the Section 165 
requirements, capital requirements and potentially other regulatory 
requirements could prevent the imposition of dead costs--costs that do 
not reduce an institution's riskiness or the risk to U.S. financial 
stability or contribute to compliance with other applicable laws and 
Federal policies--on banking organizations with consolidated assets in 
excess of $50 billion. In addition, more customized regulation and 
supervision should result in more effective oversight of banking 
organizations in the United States, some of which have very different 
business models. For example, regional banks often fund themselves with 
core deposits and focus on traditional lending, while other 
institutions choose to focus more on financial market, or custody and 
payment activities. Regulatory requirements designed to mitigate the 
risks related to financial market services are often inappropriate to 
address the risks related to more traditional banking organizations.
    Nevertheless, a more bespoke approach to the application of Section 
165 and other regulatory requirements does not solve the issue of what 
the appropriate thresholds are for such requirements to kick in. Bank 
supervision should always be, and has historically been, tailored to 
the risk profiles of specific institutions. As such, special 
requirements aimed at financial stability and the elimination of too 
big to fail should have limited application for several reasons. First, 
the identification of an institution as systemically important carries 
with it the moral hazard that the identified institutions will enjoy a 
halo effect--that market participants will be more willing to transact 
with such an institution because of the belief that it will not be 
allowed to fail. Counterparty confidence based on an institution's 
reputation for prudential standards is healthy, but confidence based on 
the perception that an institution will be bailed out by the Government 
is not desirable.
    Second, empirical data based on the BCBS risk factor information 
collected by the Board suggest that the systemic risk scores of banking 
organizations with over $50 billion in consolidated assets in the 
United States vary greatly. A study by the Office of Financial 
Research, which was created by the Dodd-Frank Act, shows scores that 
vary by a factor of over 125, ranging from 0.04 to 5.05.\3\ Moreover, 
there is a sharp inflection point at around a score of 1.5. The ninth 
highest scoring banking organization scored 1.48, but the tenth highest 
scoring bank only scored 0.49. The next highest scoring banking 
organization scored 0.38. These scores include cross-jurisdictional 
activity, which may not be as significant in measuring potential 
effects on U.S. financial stability. The dramatic differences in 
systemic risk scores suggest that the number of systemically important 
institutions is limited.
---------------------------------------------------------------------------
    \3\OFR Brief 15-01 (Feb. 12, 2015), available at http://
financialresearch.gov/briefs/files/OFRbr-2015-01-systemic-importance-
indicators-for-us-bank-holding-companies-fig-1.pdf.
---------------------------------------------------------------------------
    Third, we should continue to provide bank supervisors with the 
discretion to apply more stringent safety and soundness requirements on 
particular banking organizations with distinct risk profiles. It is not 
necessary to adopt requirements with broad applicability to capture a 
handful of unique organizations.
    Moving to such a tailored, risk-based approach to the supervision 
and regulation of banking organizations under Section 165 would require 
statutory changes. For example, the Board would need to be granted the 
ability to set different thresholds, including thresholds based on 
factors other than total consolidated assets, for all of the prudential 
requirements in Section 165. I believe that legislative changes should 
stop short of attempting to codify any particular risk evaluation 
system, such as the BCBS systemic risk scoring system. The 
understanding, identification and management of risk in banking 
organizations, and in the economy more broadly, are dynamic and 
changing. Codification of even current thinking runs the risk of 
leaving the financial system unprepared for new risks as they develop 
in the years to come.
    Finally, I recognize that granting regulators greater discretion to 
limit the application of Section 165, and potentially other regulatory 
requirements, does not guarantee that regulators will exercise that 
discretion in a way that will reduce the costs and burdens of 
traditional banking organizations. These institutions have more than 
$50 billion in assets, but they do not present the same risks to the 
U.S. economy as other larger, more complex banking organizations. I am 
not sure that there is a neat way to put a statutory floor on 
supervision and regulatory requirements that does not run the risk of 
creating loopholes; however, congressional oversight can help ensure 
that these requirements remain tailored to the actual risk presented.
                                 ______
 
 
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                    PREPARED STATEMENT OF MARK OLSON
    Co-Chair, Bipartisan Policy Center Financial Regulatory Reform 
            Initiative's Regulatory Architecture Task Force
                             March 24, 2015
    Chairman Shelby, Ranking Member Brown, Members of the Committee, 
thank you for the opportunity to testify. I am honored to appear not 
only because of the important impact that the Committee's work has on 
U.S. economic growth, financial stability and consumer protection, but 
also because of my own time working on the Committee staff, having 
served as staff director of the Securities Subcommittee.
    I appear before you today in my capacity as co-chair of the 
Bipartisan Policy Center (BPC) Financial Regulatory Reform Initiative's 
Regulatory Architecture Task Force. I co-chaired this task force with 
former New York State Superintendent of Banks Richard Neiman and am 
proud of the work that we accomplished, finding common ground and 
practical solutions to many complex issues.
    Today, I would like to focus on one of our task force's 
recommendations raising the so-called ``bank SIFI'' asset threshold 
from $50 billion to $250 billion, while giving regulators more 
flexibility to determine whether or not an institution should be 
subject to more rigorous oversight. We believe this recommendation 
strikes the right balance between assuring that financial institutions, 
whose collapse could pose a significant risk to the financial system, 
receive an appropriate level of supervision and regulation, while not 
subjecting those that do not meet this standard with needless rules and 
oversight which may impede economic growth.
    BPC was founded in 2007 by former Senate Majority Leaders Howard 
Baker, Tom Daschle, Bob Dole, and George Mitchell with the idea of 
finding bipartisan solutions to the complex policy issues facing our 
country. In 2012, BPC launched the Financial Regulatory Reform 
Initiative to assess the Dodd-Frank Act: what is working, what is not 
working, and how financial reform can be improved. Richard and I were 
asked to analyze and find ways to improve the U.S. regulatory 
structure. We spent a year-and-a-half researching and assessing this 
issue. We met with a wide variety of stakeholders, including current 
and former regulators, financial reform and industry advocates, and 
academics. We had five guiding principles in our work:

    Clarifying the U.S. regulatory architecture to close gaps 
        that could contribute to a future crisis or financial stress 
        event;

    Improving the quality of regulation and regulatory 
        outcomes;

    Better allocating, coordinating, and efficiently using 
        scarce regulatory resources;

    Ensuring the independence and authority of financial 
        regulators to allow them to anticipate and appropriately act on 
        threats to financial stability; and

    Increasing the transparency and accountability of the 
        regulatory structure.

    In April 2014, we released our report: Dodd-Frank's Missed 
Opportunity: A Road Map for a More Effective Regulatory Architecture 
that included more than 20 recommendations that we believe will help 
achieve these goals. The full report is included as an addendum to this 
testimony.
    We found a number of areas where we believe Dodd-Frank moved the 
U.S. financial regulatory structure in the right direction, including 
eliminating the Office of Thrift Supervision, creating the Consumer 
Financial Protection Bureau, and paying greater attention to oversight 
of the financial system as a whole. We also found many ways that the 
current system could be improved.
    A good example was our recommendation to change the asset threshold 
over which bank holding companies become subject to enhanced 
supervisory and regulatory requirements. These companies are sometimes 
called bank SIFIs (systemically important financial institutions) 
because they face enhanced prudential requirements, similar to those 
applied to the nonbank SIFIs, which are designated by the Financial 
Stability Oversight Council (FSOC). In the course or our research, we 
found little support for the idea that the current asset threshold, set 
at $50 billion and not indexed for any future growth, was an ideal 
solution to the real issues it was meant to address.
The Current Threshold is Problematic
    There are several problems with the current $50 billion threshold, 
which I will briefly summarize.

  1.  It is arbitrary. In general, a bank holding company with $49 
        billion in assets does not suddenly become systemically 
        important, and therefore subject to enhanced prudential 
        standards, when it grows to $51 billion in assets. Different 
        banks have different balance sheet structures and risk profiles 
        and should be judged accordingly, making the presence of a 
        ``solid-line'' or binary threshold problematic.

  2.  It includes institutions that are not systemically important. In 
        addition to being arbitrary, the $50 billion threshold captures 
        a number of bank holding companies that few would argue are, 
        individually, systemically important. This is by design. During 
        the crafting of what later became Dodd-Frank, there was real 
        concern that setting a threshold that clearly separated 
        systemic from nonsystemic institutions would reinforce the 
        moral hazard concerns associated with too big to fail. At the 
        time, policymakers worried that banks above the asset threshold 
        might be conferred with unfair benefits relative to those 
        institutions that fell below the line. It has become apparent, 
        however, that the extra oversight that applies to nonsystemic 
        institutions just above today's $50 billion asset threshold is 
        costly--both for regulators to administer and the institutions 
        subject to the regime to comply. The requirements of the new 
        regime include developing living wills and participating in 
        regular comprehensive stress tests, all of which entail 
        substantial compliance costs. Furthermore, the benefits of 
        including these firms, which are now subject to far more robust 
        supervisory regime in the post-crisis world, are smaller than 
        many expected. In his testimony before this Committee last 
        week, Federal Reserve Board Governor Daniel Tarullo said that 
        stress testing requirements, for example, ``can be a 
        considerable challenge for a $60 billion or $70 billion bank,'' 
        but that the benefits gained by including such institutions, 
        ``are relatively modest'' and that regulators ``could probably 
        realize them through other supervisory means.''\1\
---------------------------------------------------------------------------
    \1\ Application of Enhanced Prudential Standards to Bank Holding 
Companies Before the Committee on Banking, Housing, and Urban Affairs, 
U.S. Senate, Washington, DC, 114th Cong. (March 19, 2015) (testimony of 
Daniel K. Tarullo, Governor, Board of Governors of the Federal Reserve 
System). http://www.federalreserve.gov/newsevents/testimony/
tarullo20150319a.htm.

  3.  It focuses only on size. The size of a bank holding company's 
        balance sheet affects how systemically important it is, but it 
        is far from the only relevant variable. An institution's 
        potential to create systemic risk is also determined by its mix 
        of activities and practices, interconnectedness, term structure 
        of funding, leverage and a number of other factors. One can 
        imagine an institution with well over $50 billion in assets 
        that is well-capitalized, diversified, not overly 
        interconnected and engaged predominantly in low-risk, plain-
        vanilla activities the failure of which would not pose a 
        significant risk to financial stability. A number of regional 
        banks arguably fall into this category. In his testimony to 
        this Committee last week, FDIC Chairman Martin Gruenberg said 
        that of the 37 institutions above the $50 billion threshold, 20 
        of them ``are diversified commercial banks that essentially 
        take deposits and make loans.''\2\
---------------------------------------------------------------------------
    \2\ Examining the Regulatory Regime for Regional Banks before the 
Committee on Banking, Housing, and Urban Affairs, Washington, DC, 114th 
Cong. (March 19, 2015) (testimony of Martin J. Gruenberg, Chairman, 
Federal Deposit Insurance Corporation). https://www.fdic.gov/news/news/
speeches/spmarch1915.html.

     On the other hand, at certain points during the financial crisis 
        the CIT Group was considered potentially systemically important 
        given its unique position in providing credit to small 
        businesses. During that period, CIT had approximately $90 
        billion in assets, which would be below even the $100 billion 
        threshold some have proposed.\3\ Given that size is not the 
        only factor in determining whether a bank is systemically 
        important, size should not be the only factor used by the law 
        or regulators in determining whether a bank holding company 
        should be subject to enhanced oversight.\4\
---------------------------------------------------------------------------
    \3\ CIT Grp. Inc., Quarterly Report (Form 10-Q), at 2 (November 10, 
2008). http://www.sec.gov/Archives/edgar/data/1171825/
000089109208005502/e33450_10q.htm.
    \4\Mosser, Patricia. ``OFR Brief Examines Data on Systemically 
Important Bank Holding Companies.'' Office of Financial Research, 
February 12, 2015. http://financialresearch.gov/from-the-management-
team/2015/02/12/ofr-brief-examines-data-on-systemicallyimportant-bank-
holding-companies/.

  4.  It produces undesirable incentives. A binary threshold based 
        simply on size gives bank holding companies an incentive to 
        either stay below the threshold to avoid extra regulatory 
        requirements or, once they are above the threshold, to become 
        ever larger to spread out the fixed costs of those 
        requirements. If the purpose of these extra requirements is to 
        improve financial stability, then the law should focus on 
        promoting incentives for institutions to engage in less risky 
        activities and practices while still meeting the needs of their 
        customers and forming a foundation for sustainable economic 
---------------------------------------------------------------------------
        growth.

  5.  It is not indexed. Dodd-Frank as written retains a static, hard-
        wired $50 billion threshold. Each year, the real value of $50 
        billion in assets will decline as a share of the economy. 
        Because of this, the current static threshold will capture more 
        and smaller bank holding companies over time since the 
        threshold is not indexed for economic growth, inflation, or any 
        other metric. If a threshold is maintained in statute, it 
        should be automatically adjusted to avoid this effect. If the 
        threshold is indexed, I would suggest indexing it to economic 
        growth rather than inflation since the systemic significance of 
        a bank holding company is tied to an institution's size 
        relative to the economy rather than in relation to consumer 
        prices.

  6.  It diverts scarce regulatory resources. Whether they are funded 
        independently or through Congressional appropriations, 
        financial regulatory agencies face constraints on their 
        budgetary resources. They must prioritize these resources to 
        achieve the greatest benefit they can for the least cost. This 
        is particularly true in a post Dodd-Frank world where 
        regulators have far greater responsibilities and authorities. 
        The current static threshold limits their ability to do so. As 
        an example, a number of critics have argued that the process 
        for creating a living will has been intensive and time 
        consuming for bank holding companies. That is true, but what is 
        much less noted is that they are intensive and time consuming 
        for regulators as well. I do not argue that living wills have 
        not generated benefits, but those benefits are not the same for 
        all institutions regardless of their complexity and size. I 
        think that it makes little sense to tie up a significant share 
        of scare regulatory resources in systemic oversight of 
        institutions that few believe are systemically important.
Rethinking the Bank SIFI Threshold
    As is often the case, agreeing on the problems with a system is 
more difficult than agreeing on a path forward. So it is with the bank 
SIFI threshold. No regulatory regime will be perfect, but we believe 
that our BPC task force's recommendation would be a major improvement 
over the status quo.
    Our solution contains two integrated elements. First, we 
recommended raising the bank SIFI threshold to focus on bank holding 
companies that are more likely to be systemically important. 
Specifically, we suggested raising the threshold from $50 billion to 
$250 billion. We were pleased that, following the release of our 
report, the idea of raising the threshold was publicly supported by 
Governor Tarullo, and also from elected officials from both parties.
    No matter what level at which one establishes an asset-size 
threshold, it will be arbitrary and will not by itself take into 
account the complexity and risk profiles of different bank holding 
companies. As Comptroller of the Currency Thomas Curry stated in his 
testimony before this Committee last week, ``it is essential for the 
OCC to retain the ability to tailor and apply our supervisory and 
regulatory requirements to reflect the complexity and risk of 
individual banks.''\5\ Therefore, we also recommended complementing 
raising the threshold with moving from a binary, ``solid-line'' 
threshold to a presumptive, ``dashed-line'' threshold that allows 
regulators to have more discretion in applying requirements based on 
other appropriate risk factors. In effect, bank holding companies with 
more than $250 billion in assets would be presumed subject to enhanced 
prudential standards, but would be able to make a case to regulators to 
leave them out of the enhanced regime if they are well-capitalized and 
diversified and engaged predominantly in relatively low-risk activities 
and practices. On the flip side, bank holding companies below the $250 
billion asset threshold would be presumed not subject to enhanced 
prudential requirements, but regulators could include them in the 
enhanced regime if they determined any such institution to present 
significant systemic risk factors.
---------------------------------------------------------------------------
    \5\Examining the Regulatory Regime for Regional Banks: Hearing 
Before the Committee on Banking, Housing, and Urban Affairs, U.S. 
Senate, Washington, DC, 114th Cong., 2 (March 19, 2015) (testimony of 
Thomas J. Curry, Comptroller of the Currency). http://www.occ.gov/news-
issuances/congressional-testimony/2015/pub-test-2015-39-written.pdf.
---------------------------------------------------------------------------
    We believe that, taken together, these changes would realize a 
number of benefits:

  1.  They would make the threshold level less arbitrary by making it 
        presumptive. If regulators have the ability to use some 
        discretion in taking other risk factors into account, the 
        threshold becomes a starting point rather than an absolute.

  2.  The threshold would be less likely to capture institutions that 
        pose little systemic risk. Where the current ``solid-line'' 
        threshold captures a number of bank holding companies that are 
        not systemically important on their own, the higher threshold 
        removes smaller institutions from the enhanced regime while 
        giving regulators the ability to ``capture'' any that have 
        high-risk profiles. This can be achieved while reducing 
        unnecessary costs to institutions and regulators with minimal 
        loss of benefits.

  3.  The threshold would not be based simply on size. Making the 
        threshold presumptive allows for other risk factors to be taken 
        into account when determining whether an institution should be 
        subject to enhanced prudential standards.

  4.  They would better align incentives with goals. A higher and 
        presumptive threshold allows for incentives to be geared toward 
        reducing overall systemic risk rather than encouraging 
        institutions to stay below the threshold or grow well beyond 
        it. An institution that is not considered systemically risky 
        just below the asset threshold could presumably grow 
        organically to just above the threshold and not trigger a 
        systemic designation.

  5.  The threshold can be indexed. An indexed threshold will help to 
        ensure that it does not grow increasingly outdated over time. 
        Whatever threshold is set, we recommend indexing it to economic 
        growth or a similar metric.

  6.  They focus scarce regulatory resources where they are most 
        needed. A higher threshold allows regulators to prioritize the 
        use of their resources on the largest and most complex 
        financial institutions, where they can do the most to benefit 
        financial stability.

    As the entity most responsible in statute for questions of systemic 
risk and financial stability, we envision the FSOC as the entity that 
would make determinations about whether to include institutions below 
the $250 billion threshold in the enhanced oversight regime or whether 
to exclude institutions above the threshold from the regime. The FSOC 
could overturn presumption in either direction via a supermajority vote 
of the Council. We understand, however, that a case could be made for 
one or more different ways to overturn presumption, and we are open to 
other approaches. The specific mechanisms used are secondary to our 
core recommendations: to raise the threshold and make it presumptive.
Avoiding One-Size-Fits-All Regulation
    The bank SIFI threshold issue is an important example of how one-
size-fits-all regulation can pose an unnecessary regulatory burden on 
midsize banks. However, it is not the only one. There are several other 
actions Congress could take to alleviate unnecessary regulatory burden 
and improve the quality of supervision for regional banks.
    In addition to the prospect of facing enhanced supervisory and 
regulatory requirements as bank SIFIs, regional banks are already 
subject to reviews by multiple Federal and State financial regulators 
as part of the routine examination process. Indeed, the current system 
is often fragmented, with different agencies often having overlapping 
and duplicative responsibilities. We believe more coordination and 
cooperation among the regulators would lead to more efficient and 
comprehensive examination process.
    That is why our BPC task force recommended the creation of a pilot 
program for a consolidated examination force for banks subject to 
supervision by the Fed, FDIC, and OCC. Where appropriate, State 
regulators could also choose to join. This approach would enable 
examiner teams to take advantage of interchangeable elements offered by 
each agency, while at the same time, permit the development of 
specialized examination teams. For example, examiners could specialize 
in banks of certain sizes or complexity levels, geographic regions, or 
business lines. To test the feasibility of this idea, our task force 
recommended that the pilot program be overseen by the Federal Financial 
Institutions Examination Council (FFIEC).
    We believe the pilot could work for banks of any size, but it may 
be especially appropriate for regional banks given the growth in 
regulatory scrutiny they have received from regulators. Congress could 
require the regulators to implement this pilot program and consider 
expanding it depending on results.
    Another issue facing midsize banks has been the propensity to get 
ensnared by rules designed for larger, more complex financial 
institutions. Congress was wise to give the Federal Reserve and the 
FDIC a substantial degree of latitude to engage in such tailoring. We 
encourage regulators to take advantage of this authority.
    The text of Dodd-Frank includes several provisions that allow for 
and in some cases require agencies to tailor their approach. For 
example, Section 165 of Dodd-Frank, which deals with developing 
enhanced supervisory and prudential standards for nonbank SIFIs and 
bank SIFIs, says that:

        In prescribing more stringent prudential standards under this 
        section, the Board of Governors may, on its own or pursuant to 
        a recommendation by the Council . . . differentiate among 
        companies on an individual basis or by category taking into 
        consideration their capital structure, riskiness, complexity, 
        financial activities (including the financial activities of 
        their subsidiaries), size, and any other risk-related factors 
        the Board of Governors deems appropriate.\6\
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    \6\ Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. 
L. No. 111-203, 111th Cong., Section 165 (a) (2) (A). http://
www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm.

    The Federal Reserve included 40 instances of the word ``tailor'' or 
one of its permutations in its final rule implementing Section 165.\7\ 
The Federal Reserve and FDIC also jointly worked to tailor their 
requirements for both living wills and stress tests (along with the 
OCC), scaling them to some degree to account for the size and 
complexity of the institutions subject to them. And in fact, our 
recommendation to make the new threshold for banks to be subject to 
enhanced prudential standards presumptive is very much in keeping with 
Congress' desire for regulators to tailor.
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    \7\ Enhanced Prudential Standards for Bank Holding Companies and 
Foreign Banking Organizations; Final Rule. 79 no. 59 12 CFR 252 (March 
27, 2014): 17240. http://www.gpo.gov/fdsys/pkg/FR-2014-03-27/pdf/2014-
05699.pdf.
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    Regulators can and should use their tailoring authority to adjust 
their enhanced requirements based on the size, complexity and other 
risk factors of individual bank holding companies. They has worked to 
do so, for example by the Federal Reserve creating three effective 
categories of enhanced graduated requirements for bank holding 
companies between $50 billion and $250 billion in assets, between $250 
billion and $750 billion, and a third category for the 8 largest bank 
holding companies with more than $750 billion in assets. The agency can 
accomplish significant benefits through approaches like this. However, 
tailoring alone will not solve the problems I outlined earlier.
    Chairman Gruenberg testified that Dodd-Frank's stress testing 
requirements are ``more detailed and prescriptive than the language 
covering other prudential standards, leaving the regulators with less 
discretion to tailor.''\8\ And Governor Tarullo testified last week 
that there are certain kinds of prudential regulation that Congress 
required the Federal Reserve to implement for all bank SIFIs, and that 
some, such as the application of the Volcker Rule and $50 billion 
threshold, ``bear reexamination.''\9\ If regulators have determined 
areas where they believe Dodd-Frank restricts their ability to tailor 
regulations designed for the largest most complex institutions 
appropriately for smaller institutions, we as a general principal would 
support legislative change to enhance regulatory authority to implement 
tailoring.
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    \8\ Examining the Regulatory Regime for Regional Banks before the 
Committee on Banking, Housing, and Urban Affairs, Washington, DC, 114th 
Cong. (March 19, 2015) (testimony of Martin J. Gruenberg, Chairman, 
Federal Deposit Insurance Corporation). https://www.fdic.gov/news/news/
speeches/spmarch1915.html.
    \9\ Application of Enhanced Prudential Standards to Bank Holding 
Companies Before the Committee on Banking, Housing, and Urban Affairs, 
U.S. Senate, Washington, DC, 114th Cong. (March 19, 2015) (testimony of 
Daniel K. Tarullo, Governor, Board of Governors of the Federal Reserve 
System). http://www.federalreserve.gov/newsevents/testimony/
tarullo20150319a.htm.
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    From having run a family owned community bank in Minnesota, I know 
firsthand the value of America's diverse banking system. This 
diversity, however, makes one-size-fits-all regulation challenging and 
often unwise. We believe that the reforms we propose--raising the bank 
SIFI threshold and making it presumptive, encouraging a more 
coordinated approach to bank examinations, and appropriately tailoring 
rules--are both prudent and pragmatic. They would result in a more 
effective and efficient oversight, a safer financial system, and 
ultimately, a regulatory structure that encourages economic growth.
                                 ______
                                 
                PREPARED STATEMENT OF SIMON JOHNSON \1\
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    \1\ Also Senior Fellow, Peterson Institute For International 
Economics; and Co-Founder of http://baselinescenario.com, a member of 
the Congressional Budget Office's Panel of Economic Advisors, the 
Federal Deposit Insurance Corporation's Systemic Resolution Advisory 
Committee, the Office of Financial Research's Research Advisory 
Committee, and the Systemic Risk Council (created and chaired by Sheila 
Bair). All the views expressed here are mine alone. Italicized text 
indicates links to supplementary material; to see this, please access 
an electronic version of this document, e.g., at http://
baselinescenario.com. For important disclosures, see http://
baselinescenario.com/about/.
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               Ronald Kurtz Professor of Entrepreneurship
                     MIT Sloan School of Management
                             March 24, 2015
A. Main Points
  1)  Section 165 of the 2010 Dodd-Frank Act authorizes the Board of 
        Governors of the Federal Reserve System to establish ``more 
        stringent'' standards and requirements for bank holding 
        companies with assets over $50 billion compared with smaller 
        bank holding companies. At the same time, the Fed is granted 
        considerable discretion to determine exactly how to apply these 
        standards, including what requirements are imposed on different 
        size banks (Section 165(a)(2)(A)). (The precise wording of the 
        Act is discussed further in Section C below.)

  2)  As a matter of practice since 2010, the Fed has not applied one 
        set of standards to all banks with assets over $50 billion. 
        There is substantial differentiation, depending in part on 
        size, but also varying according to factors such business 
        model, complexity, and opaqueness.

  3)  This differentiation, to date, seems sensible and reasonably 
        robust--subject to the points below. It also appears completely 
        consistent with Congressional intent, expressed through Dodd-
        Frank and earlier legislation that is still in effect.

  4)  The Federal Reserve has long had responsibility for the safety 
        and soundness of the American financial system. This role can 
        be traced back to the panic of 1907, which led to the founding 
        of the Fed in 1913. The bank runs and broader economic problems 
        of the 1930s led to a re-founding of the Federal Reserve 
        System, with a clear mandate to prevent the financial system 
        from getting out of control.\2\
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    \2\ On this and broader Fed history, see Peter Conti-Brown, ``The 
Twelve Federal Reserve Banks: Governance and Accountability in the 21st 
Century,'' Working Paper #10, Hutchins Center on Fiscal & Monetary 
Policy at Brookings, March 2, 2015. For the Fed's extensive supervisory 
mandate in the 2000s, see Heidi Mandanis Schooner, ``Central Banks' 
Role in Bank Supervision in the United States and United Kingdom,'' 
Brooklyn International Law Journal, 2003, available at ssrn.com.

  5)  In the run-up to 2007-08, the Federal Reserve failed: to protect 
        consumers, to understand the buildup of risk around 
        derivatives, to supervise appropriately some large financial 
        institutions then under its jurisdiction, and to keep the 
        system from imploding.\3\ These failures were not due to lack 
        of resources or an unawareness of the changes happening within 
        the financial system. Rather there was a deliberate strategy of 
        noninterference, along with many instances of actually 
        encouraging various forms of deregulation that, in retrospect, 
        are clearly understood--including by Fed staff and Governors--
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        as having increased levels of systemic risk.\4\

    \3\ The Federal Reserve System's own mission statement has four 
bullet points. The Fed disappointed along almost every dimension of 
these stated goals in 2007-08, with the exception that it kept the 
payments system functioning.
    \4\ For the history of deregulation and the role of the Fed, see 
Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and 
the Next Financial Meltdown, Pantheon 2010, particularly chapter 4. Fed 
chairman Alan Greenspan was a leader in this push for deregulation in 
the 1980s, 1990s, and into the 2000s but, to be fair, there was a 
considerable degree of bipartisan consensus on this policy direction.

  6)  At the time of the discussions and debates that led to Dodd-
        Frank, Congress had to face the facts: almost all the banking 
        and financial sector regulators had failed in their tasks--some 
        even more spectacularly than had the Fed. (The exception was 
        the Federal Deposit Insurance Corporation, but a decision was 
---------------------------------------------------------------------------
        taken not to promote the FDIC to the role of system regulator.)

  7)  With regard to bank holding companies, Congress did not create a 
        new authority for the Fed in Dodd-Frank. Rather Congress re-
        affirmed the existing broad authority and set some minimum 
        bars--specifying bright lines to define for the Fed which kinds 
        of bank holding companies require more attention, while 
        allowing the Fed to retain a considerable degree of discretion 
        regarding what exactly that attention will involve.\5\
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    \5\ Dodd-Frank did create a new authority for the Fed vis-a-vis 
nonbank financial companies that are designated as systemic by the 
Financial Stability Oversight Council (FSOC).

  8)  At the threshold of $50 billion in total assets, bank holding 
        companies are now required to prepare resolution plans. They 
---------------------------------------------------------------------------
        must also file an integrated Systemic Risk Report (FR Y-15).

  9)  Bank holding companies with more than $10 billion in total assets 
        must conduct annual company-run stress tests. Bank holding 
        companies with more than $50 billion in total assets must 
        conduct semiannual company run stress tests and also 
        participate in stress tests run by the Federal Reserve.\6\
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    \6\ Section 165(i)(2) of Dodd-Frank is quite specific on these 
requirements. However, as applied by the regulators, there is a 
``substantially abbreviated data reporting template'' for the smaller 
banks; see Thomas J. Curry, written testimony submitted to this 
Committee, March 19, 2015.

  10)  The Fed already had authority to establish regulatory capital 
        requirements, liquidity standards, risk-management standards, 
        and concentration limits (including single counterparty credit 
        limits). All of these can be and have been tailored as the Fed 
        deems appropriate.\7\
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    \7\ Better Markets, a pro-financial reform group, has produced a 
very useful fact sheet that shows the main thresholds and how the Fed 
has chosen to apply them.

  11)  There are, of course, costs with running any sensible risk 
        management program. Many of these so-called ``compliance 
        costs'' are very much in the interests of shareholders--it was 
        deficiencies in or the complete lack of such programs that 
        resulted in heavy losses and significant financial firm 
        failures in the financial crisis. For example, the Dodd-Frank 
        requirement (Section 165(h)) of risk committees for bank 
        holding companies with more than $10 billion in assets seems 
---------------------------------------------------------------------------
        entirely consistent with the interest of shareholders.

  12)  Shareholders could, in principle, speak for themselves regarding 
        how much risk management they want and how they would like this 
        to be organized. But we must recognize the limits imposed on 
        shareholder influence over bank holding company management, 
        including through the extensive rules on ownership of banks. 
        These restrictions are, ironically, administered by the Federal 
        Reserve itself.\8\
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    \8\ See for example, the Fed's 2008 Policy statement on equity 
investment in banks and bank holding companies. On the ``many activity 
restrictions and regulatory intrusions'' involved with becoming a bank 
holding company--owning or controlling a bank--see Saule T. Omarova and 
Margaret E. Tahyar, ``That Which We Call a Bank: Revisiting the History 
of Bank Holding Company Regulation in the United States,'' Review of 
Banking and Financial Law, Vol. 31, 2011-2012, available at ssrn.com.

  13)  Some recent legislative proposals could increase our deference 
        to the Financial Stability Board (FSB), with regard to either 
        criteria or actual designation of banks as systemically 
        important. This would be unwise. The FSB plays an important 
        role in facilitating communication between regulators, but not 
        all major countries share our concern for or general approach 
        to limiting systemic risk. Relying too much on the FSB would 
        excessively cede U.S. sovereignty to a body with limited 
        accountability. It would also create the possibility of a 
        ``race to the bottom'', as happened with capital requirements 
---------------------------------------------------------------------------
        before 2007.

  14)  Other proposals suggest that the Financial Stability Oversight 
        Council (FSOC) should have to designate banks as systemic in 
        order for them to receive heightened scrutiny from the Fed. 
        This would be a strange arrangement, as FSOC by design includes 
        nonbank regulators, such as the chairs of the Securities and 
        Exchange Commission and the Commodity Futures Trading 
        Commission. Allowing or requiring nonbank regulators to tell a 
        bank regulator which banks to regulate (and potentially how to 
        regulate them) does not seem wise.

  15)  It would be helpful to require bank holding companies with at 
        least $10 billion in total assets to file a Systemic Risk 
        Report (FR Y-15). This report is concise and provides data on 
        the systemic footprint of a financial institution. Hopefully, 
        bank holding companies put together such data for their own 
        management and investors in any case. Publishing such reports 
        provides a clearer perspective, for regulators and for market 
        participants, on differences in activities and risks across 
        bank holding companies just below and just above $50 billion in 
        assets.

  16)  Should some bank holding companies with less than $50 billion in 
        total assets be subject to heightened scrutiny, for example due 
        to various off-balance sheet activities? Without seeing 
        Systemic Risk Reports for those firms, it is hard to know.

  17)  The available Systemic Risk Reports also suggest, at all size 
        levels, it would be sensible to think of bank holding company 
        size more in terms of total exposure (on-balance sheet plus 
        off-balance sheet) as defined in that report, rather than the 
        more narrow measure of total consolidated assets. (More on this 
        in Section B below.)
B. The Critical Threshold Issue
    What if the threshold for enhanced prudential standards were 
lifted, for example, to $100 billion?
    At the end of 2013, there were 10 bank holding companies that had 
assets between $50 billion and $100 billion.\9\ However, a better 
measure of potential importance to the financial system as a whole is 
``total exposure'' of a bank holding company, as defined in the 
Systemic Risk Report form. This requires a bank to report both its on-
balance sheet and off-balance sheet activities, including derivatives 
exposures and credit card commitments, in a comparable way.\10\ As we 
learned in 2007 and 2008, off-balance sheet activities are important 
and can--particularly at a time of stress--have major impact on 
solvency of financial institutions and on the spillover effects from 
potential failures.
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    \9\ This section uses information from the Systemic Risk Reports 
required by the Fed of all bank holding companies with over $50 billion 
in total assets; end of 2013 is the latest available. The form is here: 
http://www.federalreserve.gov/reportforms/formsreview/FRY15_20120822
_f_draft.pdf. The publicly available data can be accessed, by bank, 
from this Web page: http://www.ffiec.gov/nicpubweb/nicweb/
HCSGreaterThan10B.aspx.
    \10\ The instructions are here: http://www.federalreserve.gov/
reportforms/forms/FR_Y-1520131231_i.pdf.
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    In the latest available Systemic Risk Reports, from the end of 
2013, 4 of these 10 bank holding companies actually had ``total 
exposure'' (on- and off-balance sheet) over $100 billion.\11\ It is 
hard to argue that the fate of a bank holding company with a total 
exposure threshold of over $100 billion is definitely inconsequential 
to the system as a whole.\12\
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    \11\ KeyCorp had over $130 billion in total exposure, while BBVA, 
M&T Bank, and Bancwest had just over $100 billion in total exposure.
    \12\ Long-Term Capital Management (LTCM), when it was on the brink 
of failure in 1998, had on-balance sheet assets of around $125 billion, 
with capital of $4 billion. ``But that leverage was increased tenfold 
by LTCM's off balance sheet business whose notional principal ran to 
around $1 trillion''; David Shirreff, Lessons from the Collapse of 
Hedge Fund, Long-Term Capital Management.
---------------------------------------------------------------------------
    Of the six bank holding companies that had under $100 billion in 
total exposure, two are subsidiaries of large non-U.S. banks that 
recently failed the stress tests conducted by the Fed.\13\ It would 
seem unwise to suddenly regard those firms as no longer needing more 
stringent standards than required for smaller and much simpler banks.
---------------------------------------------------------------------------
    \13\ Santander USA has total exposure of $98 billion and Deutsche 
Bank (in the United States) has total exposure of over $60 billion. 
Strikingly, the assets of Santander USA increased from around $77 
billion at the end of 2013 to over $113 billion at the end of the third 
quarter of 2014--an example of how quickly a large global bank can 
shift business into its U.S. subsidiary. Too Big to Fail: The Hazards 
of Bank Bailouts, by Gary H. Stern and Ron J. Feldman (Brookings, 2004) 
highlights, among other points, the potential dangers posed by foreign 
banks operating in the United States.
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    Of the remaining four bank holding companies, two had total 
exposures between $95 billion and $100 billion. This leaves Huntington 
Bancshares Incorporated with $64 billion and Zions Bancorporation with 
$75 billion in total exposure.\14\
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    \14\ Zions has had repeated problems with the Fed-run stress tests, 
barely passing in 2015. Part of the issue appears to be its large 
portfolio of Collateralized Debt Obligations. See Julie Steinberg, 
``Zions, Regulators Still at Loggerheads,'' Wall Street Journal, March 
22, 2015.
---------------------------------------------------------------------------
    While some regional banks have relatively simple business models, 
others are at least partially more complex. For example, 5 of the 10 
bank holding companies with under $100 billion in total assets are 
(i.e., own) registered swaps dealers or have a significant exposure to 
derivatives.\15\
---------------------------------------------------------------------------
    \15\ This CFTC list is current as of March 16, 2015: http://
www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer. The OCC 
latest derivative report shows activities by bank in the third quarter 
of 2014, http://www.occ.gov/topics/capital-markets/financialmarkets/
trading/derivatives/dq314.pdf.
---------------------------------------------------------------------------
    Regional banks, including those in the $50 billion to $100 billion 
total asset range, were reportedly involved in lobbying for the repeal 
of Section 716 of Dodd-Frank, which would have ``pushed out'' some 
swaps from their insured bank subsidiaries. The repeal of Section 716 
at the end of 2014 is a further reason for the Fed and other regulators 
to pay close attention to regional banks.
    If the discussion turns to considering lifting the scrutiny and 
reporting requirements for banks having over $100 billion in total 
assets, then looking at total exposures remains important. In the 
Systemic Risk Reports for the end of 2013, all of the bank holding 
companies with over $100 billion in assets actually had total exposure 
of at least $140 billion.\16\
---------------------------------------------------------------------------
    \16\ It is hard to know what will or will not be regarded as 
systemic as the next crisis develops. IndyMac Bancorp, which failed in 
2008, had assets of just over $30 billion; in retrospect, its problems 
should have been seen at least as an early warning for the rest of the 
system. Continental Illinois, which failed in 1984, was one of the top 
10 banks in the United States, but its assets were only around $40 
billion. U.S. Gross Domestic Product in 1984, in current prices, was 
around $4 trillion, so Continental Illinois's balance sheet assets had 
a book value of about 1 percent of the size of the U.S. economy. In 
modern terms, this further confirms the notion that we should pay close 
attention as a bank's size (i.e., total exposures) reaches $150 
billion.
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C. Regulatory Interpretation of Dodd-Frank
    Some recent prominent discussion of the Dodd-Frank Act suggests 
that bank holding companies with over $50 billion are ``designated'' as 
``systemic''. But this is not what the legislation actually says and 
this is not how the law has been interpreted by regulators.
    Section 165(a)(1) of the 2010 Dodd-Frank Wall Street Reform and 
Consumer Protection Act reads:

        ``In order to prevent or mitigate risks to the financial 
        stability of the United States that could arise from the 
        material financial distress or failure, or ongoing activities, 
        of large, interconnected financial institutions, the Board of 
        Governors shall, on its own or pursuant to recommendations by 
        the Council under section 115, establish prudential standards 
        for nonbank financial companies supervised by the Board of 
        Governors and bank holding companies with total consolidated 
        assets equal to or greater than $50,000,000,000 that----

      (A)  are more stringent than the standards and requirements 
        applicable to nonbank financial companies and bank holding 
        companies that do not present similar risks to the financial 
        stability of the United States; and

      (B)   increase in stringency, based on the considerations 
        identified in subsection (b)(3).''

    Section 165(a)(2) stipulates that the Board of Governors may 
``differentiate among companies on an individual basis or by category, 
taking into consideration their capital structure, riskiness, 
complexity, financial activities (including the financial activities of 
their subsidiaries), size, and any other risk-related factors that the 
Board of Governors deems appropriate.'' And the threshold for applying 
some standards may be set above $50 billion.
    The Federal Reserve appears to have interpreted this and related 
sections of Dodd-Frank exactly as intended, i.e., as requiring 
additional scrutiny for bank holding companies over $50 billion, 
compared with smaller bank holding companies, but not as requiring that 
all bank holding companies over $50 billion be treated the same 
way.\17\
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    \17\ Governor Daniel K. Tarullo discussed the Fed's ``tiered 
approach to prudential oversight'' most recently in his testimony 
before this Committee on March 19, 2015: http://www.federalreserve.gov/
newsevents/testimony/tarullo20150319a.pdf.
---------------------------------------------------------------------------
    Martin J. Gruenberg, chairman of the FDIC, confirms that this is 
how regulators have interpreted the law.\18\
---------------------------------------------------------------------------
    \18\ These quotes are from his recent testimony to this Committee, 
March 19, 2015.

        ``In implementing the requirement for resolution plans, the 
        FDIC and the Federal Reserve instituted a staggered schedule 
---------------------------------------------------------------------------
        for plan submissions to reflect differing risk profiles.''

    And,

        ``The FDIC's stress testing rules, like those of other 
        agencies, are tailored to the size of the institutions 
        consistent with the expectations under section 165 for 
        progressive application of the requirements.''

    Overall, the Dodd-Frank financial reforms told the Fed to be more 
careful in its regulation of bank holding companies with more than $50 
billion in total assets, but there was definitely no one-size-fits-all 
requirement. The Fed and other regulators seem to have followed both 
the letter and spirit of this instruction.

              Additional Material Supplied for the Record
              
              
  [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]            
              

RESPONSE TO WRITTEN QUESTION OF CHAIRMAN SHELBY FROM OLIVER I. 
                            IRELAND

Q.1. Mr. Ireland, during the hearing there was disagreement as 
to whether the Federal Reserve has the authority to establish 
an asset threshold above $50 billion for certain prudential 
standards, specifically, resolution plans. Please explain why 
you believe the Federal Reserve does not have the authority to 
establish a higher threshold for resolution plans.

A.1. As I noted in my testimony, the language of Section 165 of 
the Dodd-Frank Act on the Federal Reserve's authority to 
establish an asset threshold above $50 billion for certain 
prudential standards, such as resolution plans, is confusing. 
Section 165(a)(2)(B) states:

    (B) LADJUSTMENT OF THRESHOLD FOR APPLICATION OF CERTAIN 
        STANDARDS.--The Board of Governors may, pursuant to a 
        recommendation by the Council in accordance with 
        section 115, establish an asset threshold above 
        $50,000,000,000 for the application of any standard 
        established under subsections (c) through (g).

While this language authorizes the Federal Reserve Board to set 
higher thresholds for standards established under subsections 
(c) through (g), it does not authorize the Board to set higher 
thresholds for standards established under subsection (b).
    Subsection (b) states:

    (b) LDEVELOPMENT OF PRUDENTIAL STANDARDS.----

      (1) LIN GENERAL.----

        (A) LREQUIRED STANDARDS.--The Board of Governors shall 
        establish prudential standards for nonbank financial 
        companies supervised by the Board of Governors and bank 
        holding companies described in subsection (a), that 
        shall include----
           (i) Lrisk-based capital requirements and leverage 
        limits, unless the Board of Governors, in consultation 
        with the Council, determines that such requirements are 
        not appropriate for a company subject to more stringent 
        prudential standards because of the activities of such 
        company (such as investment company activities or 
        assets under management) or structure, in which case, 
        the Board of Governors shall apply other standards that 
        result in similarly stringent risk controls;

           (ii) Lliquidity requirements;

           (iii) Loverall risk management requirements;

           (iv) Lresolution plan and credit exposure report 
        requirements; and

            (v) Lconcentration limits.

    To the extent that the Board is following the mandate in 
Section 165(b)(1)(A)(iv) in establishing standards for 
resolution plans, it is not authorized to establish a higher 
threshold under Section 165(a)(2)(B) above.
    Confusion arises however, when Sections 165(a) and 165(b) 
are read in conjunction with Section 165(d) which provides:

    (d) LRESOLUTION PLAN AND CREDIT EXPOSURE REPORTS.----

        (1) LRESOLUTION PLAN.--The Board of Governors shall 
        require each nonbank financial company supervised by 
        the Board of Governors and bank holding companies 
        described in subsection (a) to report periodically to 
        the Board of Governors, the Council, and the 
        Corporation the plan of such company for rapid and 
        orderly resolution in the event of material financial 
        distress or failure, which shall include----

            (A) Linformation regarding the manner and extent to 
        which any insured depository institution affiliated 
        with the company is adequately protected from risks 
        arising from the activities of any nonbank subsidiaries 
        of the company;

            (B) Lfull descriptions of the ownership structure, 
        assets, liabilities, and contractual obligations of the 
        company;

            (C) Lidentification of the cross-guarantees tied to 
        different securities, identification of major 
        counterparties, and a process for determining to whom 
        the collateral of the company is pledged; and

            (D) Lany other information that the Board of 
        Governors and the Corporation jointly require by rule 
        or order.

    Simply put, Section 165(a)(2)(B) allows the Board to 
establish higher thresholds for resolution plans created under 
Section 165(d) but not for resolution plans created under 
Section 165(b) even though both of these provisions require the 
creation of resolution plans. The inconsistency in the language 
of these sections is clear.
    We note that in adopting resolution plan requirements the 
Board used the $50 billion threshold. While it asserted the 
right to set a higher limit under section 165(d),\1\ it did not 
choose to do so, nor did it explain why it did not.
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    \1\ 76 Fed. Reg. 67,323, 67,334, n.16 (Nov. 1, 2011).
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    While canons of statutory construction and Chevron 
deference could lead to a conclusion that a higher threshold 
set for resolution plans under Section 165(d) by Board 
regulation would be valid, the conflicting statutory language 
with respect to this requirement and other requirements of 
Section 165 should be revised to remove the uncertainty created 
by the inconsistency.
                                ------                                

  RESPONSE TO WRITTEN QUESTION OF SENATOR REED FROM MARK OLSON

Q.1. The Bipartisan Policy Center has recommend the creation of 
a pilot program, which calls for a consolidated examination 
effort that would put together examiners from each of the OCC, 
Federal Reserve, and FDIC into one unit that could issue single 
examination reports for banks. Could you explain why the 
Bipartisan Policy Center is in support of this proposal?

A.1. Thank you for that question, Senator. I and Richard 
Neiman, my colleague as co-chair of BPC's Regulatory 
Architecture Task Force, made and support this proposal because 
it would improve the quality of bank supervision on numerous 
levels, and would do so in a way that would benefit all 
stakeholders. Specifically, a program of consolidated 
examination task forces would improve communication among 
prudential regulators, better coordinate and more efficiently 
use scarce regulatory resources, reduce the supervisory burden 
on both banks and agencies, allow State regulators to leverage 
Federal resources while preserving the dual banking system, and 
put better and more actionable data more quickly into the hands 
of regulators.
    As you know, banks and thrifts, and their holding 
companies, are subject to examination by multiple Federal and 
State financial regulators. Prudential supervision ensures that 
financial institutions are sufficiently capitalized, are not 
engaging in activities that are too risky, are liquid enough to 
meet their obligations, and are otherwise safe and sound. The 
current examination system, however, is fragmented, with 
overlapping and duplicative responsibilities. A banking entity 
that consists of only a parent holding company and a subsidiary 
national bank, would be subject to examinations by the Federal 
Reserve Board (for the holding company), the OCC (for the 
national bank), and the FDIC (as the insurer of the national 
bank), just for solvency regulation. If the holding company 
also owned a State-chartered bank, then that bank would be 
subject to examination by the State and either the FDIC or a 
Federal Reserve Regional Bank, depending on whether the State 
bank is a member of the Federal Reserve System or not. Each of 
these agencies has a specific mission and focus, leading 
examiners for the agencies to pursue different objectives. 
There is a significant opportunity for greater coordination and 
cooperation among the Federal prudential banking agencies since 
they share a common safety-and-soundness goal and have limited 
resources.
Proposed solution
    Our proposed solution is to create a pilot program for a 
consolidated examination force with participation from the 
three Federal prudential banking agencies (the Federal Reserve, 
FDIC, and OCC). The pilot program would be directed by a new 
supervisory committee within the Federal Financial Institutions 
Examination Council (FFIEC), an agency designed to foster 
cooperation among its member agencies, including the three 
prudential bank regulators. The voting Members of the Committee 
would be the heads of supervision of the three prudential 
banking agencies and the FFIEC's State banking regulator.
    The supervisory committee would select a group of banks of 
varying characteristics (e.g., size, complexity, type of 
charter, and State of domicile) to participate in the pilot 
program. For each institution, the committee would create a 
consolidated examination task force made up of examiners from 
each agency with jurisdiction for that institution. The task 
force would be led by the institution's primary regulator, but 
examiners from each participating agency would work together 
to:

   LDevelop a single set of supervisory questions to 
        ask an institution;

   LJointly examine each institution; and

   LEnsure that each examination produces a single, 
        combined report that is available to all agencies that 
        participate in a particular exam.

    A task force could be assigned to conduct a full 
examination of an institution, or could be assigned to conduct 
a more targeted examination, such as for risk management or 
Volcker Rule compliance. Further, State banking regulatory 
agencies would be invited to participate in task forces that 
are assigned to institutions within their respective States, 
allowing them leverage Federal resources to an extent they 
would not otherwise be able.
    The committee would be responsible both for building and 
executing the pilot program in a way that tests its 
effectiveness under a variety of conditions, including 
coordinating consistent supervisory priorities, protocols and 
procedures for examination task forces and otherwise ensuring 
coordination among participating agencies. The committee would 
also be responsible for assessing the pilot program's 
effectiveness and making recommendations to improve the 
operation of consolidated examination task forces.
    A well-designed and pilot program would realize a number of 
advantages:

   LConsolidation would improve communication among 
        supervisory teams since examiners would be trained 
        under a common framework and be overseen by a unified 
        committee of supervisors drawn from the three agencies. 
        Since financial stability can be threatened by a lack 
        of communication among agencies, the advantages of this 
        structure should be substantial.

   LRegulators could better leverage their specialist 
        personnel, whose expertise would be usable across a 
        wider set of institutions. This would improve the 
        overall quality of examination teams, because those 
        teams would be able to draw on a wider variety of 
        experiences and best practices.

   LThe quality of State regulation would be 
        significantly boosted by allowing individual States to 
        leverage Federal examination teams to assist in State 
        examinations. State agencies often cannot afford to 
        employ multiple specialists or do not have the overall 
        level of resources available to the Federal agencies. 
        To the extent that the Federal examiner training and 
        procedures incorporate individual State supervision 
        objectives, State bank supervisors may elect to put 
        greater reliance on accepting a Federal examination in 
        lieu of a separate State examination. Federal 
        regulators would also benefit from better information-
        sharing with States through this process.

   LConsolidated budgeting for examiners and 
        examinations would enable the agencies to better 
        coordinate and apply examiner teams to particular lines 
        of business or institutions.

   LUniform standards for training and management of 
        examiners and supervisors should lead to more 
        consistent and translatable examination results and 
        expectations, as well as streamlining the process for 
        both regulators and financial institutions.

   LHuman capital among examination teams would be 
        developed by providing greater opportunities for career 
        advancement, consistent and higher compensation 
        standards, and a better-defined and supported career 
        path.

   LIntegrating key support operations--such as hiring, 
        training, compensation, and promotions--for examiners 
        should make the management of the examination force 
        more efficient and less costly compared with sustaining 
        the same functions at multiple agencies.

   LIt would enable examiner teams to take advantage of 
        interchangeable elements offered by each agency. At the 
        same time, it would permit the development of 
        specialized teams. For example, examiners could 
        specialize in banks of certain sizes and complexities, 
        geographic regions, or predominant lines of business 
        (e.g., agricultural loans, small-business lending, 
        commercial real estate, and derivatives).

    These proposals exist in harmony with the dual banking 
system. The task force believes that the existence of both 
federally chartered and State-chartered banks provides great 
benefits, offering more choices for consumers and allowing for 
greater policy innovation by individual States. The 
consolidated examination force envisioned here will provide 
more and better resources to both State and Federal 
jurisdictions, thereby improving the quality of supervision 
across the board.
    A pilot program would improve and enhance the efficiency 
and quality of the examination and supervision of insured 
depository institutions and their holding companies through 
better coordination and training with improved efficiencies.
                                ------                                

 RESPONSE TO WRITTEN QUESTION OF SENATOR VITTER FROM MARK OLSON

Q.1. Mr. Olson in your written statement you described the 
complications with the arbitrary SIFI threshold of $50 billion 
and presented different ideas to overcome this arbitrarily 
threshold.
    What threshold amount or formula would you propose for 
small or community banks where the current threshold is at $10 
billion?

A.1. Thank you for that question, Senator. Although I and 
Richard Neiman, my colleague as co-chair of BPC's Regulatory 
Architecture Task Force, did not make a specific recommendation 
regarding a threshold for community banks, I believe that the 
principles we articulate in reference to the so-called ``bank 
SIFI'' threshold apply here as well.
    In short, financial regulatory agencies should focus a 
greater share of their scarce resources on the institutions and 
activities most likely to produce systemic risk that might 
threaten financial stability. While any threshold will 
inherently be arbitrary, it is clear that the risk presented by 
smaller banks that are well-managed, well-capitalized and 
engaged predominantly in plain-vanilla activities is 
significantly lower than that presented by larger banks with 
high-risk profiles. Regulators can and should tailor their 
regulation to account for these differences.
    We also believe that there is a need to index any threshold 
of this type. Currently, these thresholds in Dodd-Frank are 
static, meaning that over time, their real value will decline 
relative to a number of economic measures. In effect, a static 
$10 billion threshold will capture more small banks over time 
much the same way that a dollar buys less than it did 20, 50, 
or 100 years ago. We believe these thresholds should be indexed 
to GDP or perhaps the overall size of the banking industry, 
rather than to a metric like inflation. This is because the 
most relevant criterion in determining a bank's impact on the 
financial system is how significant that bank is relative to 
the economy or the financial system rather than the purchasing 
power of a dollar.
                                ------                                

RESPONSE TO WRITTEN QUESTION OF SENATOR REED FROM SIMON JOHNSON

Q.1. I think it may surprise most of my colleagues to learn 
that the employees at the regional Federal Reserve banks are 
not currently subject to the same ethics laws that other 
Government employees are subject to. Do you think that the 
employees at the regional Federal Reserve banks should be 
subject to the same ethics laws that Government employees are 
subject to, such as the ban on accepting gifts from regulated 
entities?

A.1. Yes, employees at the regional Federal Reserve banks 
should be subject to the same ethics laws as all other 
Government employees, including the ban on accepting gifts from 
regulated entities.
    The Federal Reserve System is an important part of the 
American Government. Within the Fed System, the Federal Reserve 
banks operate as important components of policymaking and 
implementation. People working in these banks are essentially 
Government employees, with all the responsibilities that this 
entails.
    Through some quirks of legal and political history, some 
Federal Reserve employees are not treated the same as other 
Government employees, for example with regards to ethics law. 
This is a problem that should be addressed. The current 
situation only undermines the legitimacy and the effectiveness 
of the Fed.
```