Cheat Sheet: Regulators Preview Big Changes at Senate Hearing

WASHINGTON — Lawmakers and regulators tussled Tuesday over how the agencies are implementing key provisions of the Dodd-Frank Act.

Members of the Senate Banking Committee pressed top regulators on a host of issues, including plans to raise capital standards on the biggest banks, potential changes to a new liquidity rule, and efforts to reduce the regulatory burden for the smallest institutions.

Below are four key takeaways from the hearing:

Tarullo previews higher capital surcharge for the largest institutions

Federal Reserve Board Gov. Daniel Tarullo unveiled plans to propose stricter capital surcharges on the eight largest, systemically important banks.

While the surcharge framework laid out under the Basel III accord will serve as a "starting point," Tarullo said that the Fed will extend the range of surcharges beyond what the Basel Committee approved. The international agreement says that the largest, most globally active banks will face a surcharge between 1% to 2.5% depending on their riskiness.

But Tarullo said it could potentially go beyond that range, in part because the agencies plan to take into account banks' continued reliance on short-term wholesale funding.

The Fed governor argued that beyond providing additional protections for some of the most systemically important institutions, the surcharges provide the largest banks a "trade off," as they consider whether to pursue risky activity.

"If the firm really thinks that… it has to be this big and this complicated to engage in certain activities… then it can do so, but it has to have very high levels of capital," Tarullo said. "If on the other hand, those highest levels of capital appear to not be worth it, then it has the option of changing what people call its systemic footprint."

Tarullo's remarks build on ideas he laid out in May of last year, in which he acknowledged that an "indirect measurelike a capital charge might have to be quite large to create adequate incentive to temper the use of short-term wholesale funding."

Tarullo did not offer a new capital range.

Schumer blasts decision to exclude munis from liquidity rule

Sen. Charles Schumer, D-N.Y., sharply criticized the regulators for their decision to leave out municipal bonds under their recent liquidity rule, despite a strong push from industry to include the securities in the final regulation.

The Fed, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. released a final rule earlier this month mandating that large banks must keep certain levels of "high-quality liquid assets" to cover cash outflows for 30 days in a crisis.

"Investment-grade municipal bonds not only serve as the mechanism through which we're able to create jobs and finance critical infrastructure, but the securities serve as high-quality assets that adequately cover liquidity outflows in periods of stress," Schumer said. "I've not yet heard a convincing argument why, for instance, corporate debt can be considered a high-quality asset, but investment-grade municipal securities cannot."

Tarullo, Comptroller Thomas Curry and FDIC Chairman Martin Gruenberg all indicated they would be open to reconsidering the issue down the line. A recent Fed staff analysis recommended the development of a proposal to include certain state and municipal securities under the rule.

Lawmakers, regulators tee up a host of regulatory relief concerns.

Lawmakers on the banking panel and agency officials repeatedly turned to key regulatory relief priorities that could gain attention later this year or in the new Congress.

Several lawmakers pointed, for example, to pending legislation that would clarify the Fed's role in creating capital standards for non-banks. The bipartisan bill sailed through the Senate, but has been held up in the House.

As a result, the Fed has been forced to take a "two-track" approach to the capital standards, considering what they can do if the measure passes and if it doesn't, Tarullo said.

Separately, the Fed governor elaborated on his support for raising the asset threshold to designate systemically important banks above $50 billion, an issue of interest for several lawmakers who have warned that the stress testing process and related requirements are too burdensome for banks of that size.

"Their balance sheets are pretty easily investigated by us, and their lending falls in a fairly discrete number of forms," Tarullo said of the smaller banks considered systemically important, noting that the Fed now has "the benefit of several years" of stress tests under its belt to help analyze the appropriateness of the threshold.

Sen. Mark Warner, D-Va., spoke more broadly about the need for some tweaks to the financial reform law, particularly for smaller institutions.

"I think we need to acknowledge again that historically Congress never gets it a hundred percent right," he said. "You've got to come back and do fix-it bills. And I think it is time for a fix-it bill around Dodd-Frank."

Many of these concerns are likely to make headlines again next week at a Banking Committee hearing with regulators and community bankers.

Warren strikes again about failure to prosecute individual bankers

Sen. Elizabeth Warren, D-Mass, reiterated her frustration with the Justice Department's efforts to punish big banks for breaking the law, arguing that prosecutors have failed to go after individuals at the root of the bad behavior.

Justice Department officials recently settled with Bank of America for mortgage fraud stemming from the financial crisis for a landmark $16.65 billion, following similar settlements with Citigroup and JPMorgan for $7 billion and $13 billion, respectively.

But despite those deals, "not a single senior executive at these banks has been criminally prosecuted," Warren said, arguing that the settlements don't "provide a deterrent" because the costs are ultimately paid by shareholders, not the company's management.

The banking regulators can't prosecute individuals directly, but Warren pressed witnesses for information on the number of big-bank executives they've referred to the Department of Justice for future prosecution.

Tarullo said he didn't have a number, but argued that the Fed has been working to do what it can under its existing authority.

"What we do have is the power to insist that firms either discharge current employees who have been implicated, even if they haven't been criminally prosecuted, which we've done in the past couple of cases," he said. "Or as we are doing now, conducting investigations under the authorities that are already in the law that would allow us to ban these people from working in the industry."