daniel k tarullo : capital and liquidity standards testimony by mr daniel k tarullo, member of the board of governors of the federal reserve system, before the committee on financial services, us house of representatives, washington dc, 16 june 2011. * * * chairman bachus, ranking member frank, and other members of the committee, thank you for your invitation to testify today about capital and liquidity standards and their relationship to international competitiveness. i will start by explaining how new international standards on regulatory capital and liquidity will foster global financial stability. next, i will discuss several areas in which international work to enhance the resiliency of the financial system continues. then i will turn to the agenda for implementation of these standards across national jurisdictions, as well as reforms in other areas such as derivatives markets and resolution regimes. in particular, i will address the need to expand the implementation agenda beyond assuring that the international standards are incorporated into national legislation and regulations. this is especially the case where the opaqueness of financial firms hinders observation of compliance with applicable standards, such as with minimum capital and liquidity requirements. here it will be essential for international bodies of regulators to adopt effective oversight and monitoring mechanisms, in order to achieve the financial stability benefits that the minimum standards promise, to prevent the emergence of significant competitive disadvantages for internationally active firms, and promote international cooperation in addressing the technical and policy questions that will arise. capital and liquidity standards the recent financial crisis exposed significant weaknesses in the regulatory capital requirements for large banking institutions in many parts of the world, including the united states. the amount of capital held by many banking institutions proved to be inadequate given the risks that had built up in the financial system. in some cases, especially for holdings of asset - backed securities in the trading books of the largest banks, it was evident that capital requirements were set far too low. in addition, it became apparent that some of the instruments that qualified for regulatory capital purposes as tier 1 capital, which was the core measure of capital adequacy, were not truly loss absorbing, at least not in a way that permitted a financial firm to remain a viable financial intermediary. during the crisis, market assessments of the strength of financial firms focused on common equity, the most loss - absorbent form of capital. many market participants questioned whether levels of common equity at the largest institutions would be sufficient to withstand potential losses. in conducting stress tests under the supervisory capital assessment program in the winter and early

##ended consequences arising from the specifics of the lcr. for this reason, the federal reserve, supported by our counterparts from a number of other central banks, suggested a multi - year observation period before the lcr takes effect. during this period, the u. s. agencies and a basel committee working group will collect data, solicit comments from banks, analyze the effects of the new liquidity measures on financial markets and the broader economy, and determine whether the standards need to be amended to avoid adverse unintended consequences. with respect to the nsfr, while the basel committee countries are committed to having this standard in place in 2018, considerable technical work is still needed to refine this measure in the coming years. in addition to these ongoing efforts regarding capital and liquidity, i would like to emphasize the importance of international cooperation on reforms to the derivatives market. in the united states, the market regulators and banking agencies are implementing the requirements of the dodd - frank act to strengthen the infrastructure and regulation of the otc derivatives market. this task includes enhancing the role of central counterparties, which can be an important tool for managing counterparty credit risk in the derivatives market, and introducing new margin requirements for certain derivatives activities that are not cleared with a central counterparty. even as these initiatives are underway in the united states, it is important that progress on reforming the otc derivatives market continue at the international level. in 2009, the group of twenty ( g - 20 ) leaders set out commitments related to reform of the otc derivatives markets that, when implemented by national authorities, will form a broadly consistent international regulatory approach. 1 as work on the g - 20 commitments is being pursued in a number of international groups, continued attention will be required to ensure that the convergence process continues in a timely fashion. in addition, there is need for agreement on a topic not covered by the g - 20 declaration – that of global minimum margin requirements for derivatives not cleared through a central counterparty. such an agreement would increase the stability of the financial system by reducing the likelihood of a race to the bottom in jurisdictions that do not implement equivalent standards. a final issue that must remain on the international reform agenda is the development in major financial centers of effective resolution regimes for sifis. the dodd - frank act gave the federal deposit insurance corporation ( fdic ) authority to resolve failing financial firms where necessary to mitigate serious effects on financial stability. the efficacy of this mechanism and market discipline more generally will both