Outlook 2019: Can regulators finish what they started?

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WASHINGTON — Bank regulators have a lot of work lined up for them in 2019, having unveiled several pivotal regulatory proposals on matters ranging from stress testing to capital changes to a retooling of how they implement the Community Reinvestment Act.

How far they are able to go down the road to finalizing those proposals, however, depends in large part on whether circumstances cooperate — and some observers see trouble ahead.

“Markets change regulatory agendas faster than anything,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics. “If the agencies are surprised — and I rather suspect that they will be — we’ll see a very different 2019 than the steady-as-you-go agendas the agencies are putting out.”

After a somewhat slow start, the Trump administration in 2018 filled out its full complement of banking regulators. Federal Deposit Insurance Corp. Chair Jelena McWilliams was sworn in in June, and two additional members of the Federal Reserve Board — Vice Chairman Richard Clarida and Gov. Michelle Bowman — were sworn in later in the fall.

They joined a regulatory overhaul that was already well underway. In a single week in April, the Federal Reserve proposed a rule replacing many of the agency’s minimum capital requirements with a so-called stress capital buffer and a separate rule with the Office of the Comptroller of the Currency that would revamp the enhanced supplementary leverage ratio.

The OCC also took the an early step toward recasting its rules implementing the Community Reinvestment Act — the first major reconsideration of the rules in decades. And the FDIC recently unveiled its community bank leverage ratio that would absolve banks with less than $10 billion in assets from many of the Basel III capital rules if they retain a 9% tangible asset equity leverage ratio.

The FDIC also opened the door to changing its rules for brokered deposits earlier this month, and comments from the Fed's vice chairman of supervision, Randal Quarles, and McWilliams about the potential for an expanded role for industrial loan companies may signal regulatory changes on that front as well.

Added to those priorities was the passage in May of a Senate bill that modified several aspects of Dodd-Frank’s post-crisis regulations, including giving the Fed the discretion to apply enhanced prudential standards to banks with assets of $100 billion to $250 billion.

The Fed in October proposed precisely how it intended to do that, creating a four-tiered system that relieved banks on the lower end of the asset spectrum of many of their macroprudential obligations, while leaving most of the rules for the eight largest banks intact. The Fed noted that it would issue subsequent proposals to amend the macroprudential rules for foreign banking organizations and would work with the FDIC to amend the process for banks to submit resolution plans.

Aaron Klein, policy director of the Center on Regulation and Markets at the Brookings Institution, said that with the full complement of regulators and a regulatory blueprint fleshed out, the coming year is being viewed as the fulfillment of the regulatory promises that the banking industry expected with President Trump’s election in 2016.

“I think 2019 is the year in which regulators begin to do what some in the market thought was going to happen in 2017,” Klein said. “This is the first year of the Trump administration’s financial regulatory plan.”

But he agreed with Petrou that events have a way of changing even the best-laid plans. As a staffer for Sen. Paul Sarbanes in the early 2000s, Klein saw how the former senator made great plans for his chairmanship of the Senate Banking Committee when he took the gavel in 2001. But the emergence of the Enron and Arthur Andersen accounting scandals that year absorbed all of the committee’s attention, leaving his earlier priorities on hold.

The same principle will likely apply to the bank regulators if there is an asset crash, and it can be hard to know ahead of time which institutions would be affected or how deeply.

“In the banking industry, when the economy turns, there’s always a sector where there’s been too much lending,” Klein said. “A lot of folks are focused on leveraged lending; I’m a little more focused on auto. There will be a few financial institutions caught in that … whatever it is.”

One way the economic outlook could crowd the Fed’s agenda is by making the agency think about raising its countercyclical capital buffer. Fed Gov. Lael Brainard earlier this month suggested that there were “several potential advantages” to raising the capital buffer for large banks in the near term, citing weakness in the corporate bond market and heightened concerns around leveraged lending.

Powell went out of his way during a press conference a few weeks later to say that the Fed would consider raising the buffer early in 2019, and that he was “absolutely willing” to raise the buffer if conditions warranted.

Ian Katz, director at Capital Alpha Partners, said that the economy isn’t the only thing that could hamper regulators. Another obstacle is the ability of Rep. Maxine Waters, D-Calif. — the current ranking member of the House Financial Services Committee who is nominated to become chair of the committee when Democrats take over the chamber in January — to call regulators to testify and send them official letters.

Those testimonies require a great deal of preparation, not only from the heads of the banking agencies themselves but from counsel and top staff directors as well.

“I think the regulatory agenda will get slowed down by House Financial Services — not stopped, but slowed,” Katz said. “If those people are tied up with testimony, or answering letters from lawmakers, it can slow them down. It's impossible to measure in a precise way, but it's real.”

And in some cases, the rules themselves are the obstacle.

Isaac Boltansky, an analyst with Compass Point Research & Trading, said that in many cases, the rules are not only complex but interconnected. One example of this is the Fed’s capital surcharge for global systemically important banks, or G-SIBs. The Fed’s stress capital buffer proposal and eSLR proposal rely on the G-SIB surcharge as a way of tailoring the proposals to a bank’s systemic risk. But that has led some members of Congress to suggest that the Fed should revise the G-SIB surcharge as well — a move that the central bank has been reluctant to do.

“Regulators want to revise each one of these individually, but they are layered and interwoven constructs, which adds a multiplier to both the complexity and timeline,” Boltansky said.

And some of the rules are just politically and logistically fraught. Klein said he thought that Comptroller of the Currency Joseph Otting’s quest to revise the Community Reinvestment Act may be particularly challenging, and his choice to move forward with rule revisions ahead of the other regulators could end up putting those other agencies in a bind.

“I think Otting’s decision to prioritize CRA in the absence of a large constituency clamoring for CRA reform has the potential to divert significant resources away from other regulators’ priorities,” Klein said. “The FDIC and the Fed will be forced to decide, ‘Are you going along with the OCC or not? If so, you’re drawn into that. And if not, why not?' ”

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