WASHINGTON — The Federal Reserve’s top regulator laid out some initial thoughts on how the agency plans to apply enhanced prudential standards to banks with assets of $100 billion to $250 billions.

Speaking before a banking conference in Utah on Wednesday, Fed Vice Chairman for Supervision Randal Quarles suggested that banks in that range could get a break from filing resolution plans — also called living wills — and that the Fed may consider reducing the frequency of stress tests for some institutions.

"We should consider limiting the scope of application of resolution planning requirements to only the largest, most complex, and most interconnected banking firms because their failure poses the greatest spillover risks to the broader economy,” Quarles said. (Under the Dodd-Frank Act, the Fed enforces living-will requirements along with the Federal Deposit Insurance Corp.)

Quarles said tailoring regulations to meet the risks posed by individual firms is a policy that the central bank has been engaged in for some time.

“As the board built its post-crisis framework, supervision and regulation were designed to increase in stringency in tandem with a firm’s size and systemic footprint,” Quarles said.

Federal Reserve Vice Chairman for Supervision Randal Quarles
“As the board built its post-crisis framework, supervision and regulation were designed to increase in stringency in tandem with a firm’s size and systemic footprint,” said Randal Quarles, the Fed's vice chairman for supervision. Bloomberg News

Congress passed a bill in May that raised Dodd-Frank’s threshold for enhanced prudential standards from $50 billion to $250 billion, but left the application of enhanced prudential standards for banks between $100 billion and $250 billion to the Fed.

As the agency considers how to apply those rules to midsized banks, the factors that the Fed already applies to global systemically important banks, or G-SIBs, could serve as a logical starting point. Those factors, he said, include size, cross-border activity, reliance on short-term wholesale funding and nonbank activities.

“In applying enhanced prudential standards for firms with total assets of more than $100 billion, Congress requires the Board to consider not only size but also capital structure, riskiness, complexity, financial activities, and any other factors the board deems relevant,” Quarles said. “While we use similar factors to calibrate the largest firms’ G-SIB surcharges, we have not used them more holistically to tailor the overall supervision and regulation of large banks that do not qualify as G-SIBs.”

Quarles went on to reiterate that banks that do not qualify as G-SIBs should also be granted some measure of regulatory relief, even if their asset sizes exceed the $250 billion threshold.

“This review should ensure that our regulations continue to appropriately increase in stringency as the risk profiles of firms increase, consistent with our previously stated tailoring goals and the new legislation," he said. "The supervision and regulatory framework for these firms should reflect that there are material differences between those firms that qualify as U.S. G-SIBs and those that do not."

Quarles’ comments came as Fed Chairman Jerome Powell was peppered with questions from the House Financial Services Committee about when the agency would issue a proposal regarding banks with assets of $100 billion to $250 billion, and what that proposal would contain.

Powell demurred, saying only that the agency is working diligently to issue a proposal.

“We’re in the process now of thinking about the factors that we’re going to think about,” Powell said in his second of two congressional hearings this week. “The bill gives us a lot of flexibility. We’re going to publish a framework that says how we’re going to look at activities and institution below $250 [billion], and then we’re going to hear back from the world about how we did and how we should think about these things.”

Quarles was somewhat more explicit on the timing of the proposal, noting that the law requires the Fed to issue a final rule within 18 months of passage, but that the agency “can and will move much more rapidly than this.”

Quarles did say that regulators “should consider scaling back or removing entirely resolution planning requirements” for banks with assets of $100 billion to $250 billion. He noted that many of those institutions “do not pose a high degree of resolvability risk, especially if they are less complex and less interconnected.”

But he also said that certain provisions would likely remain in place for banks with more than $100 billion in assets. He said that “both risk-based and leverage capital requirements should remain core components of regulation” for banks above $100 billion, and that “stress testing should continue to play an important role in assessing potential losses” at those firms.

He further suggested that the Fed’s proposed stress capital buffer — an idea that uses a firm’s prior-year performance in the stress test as a determinant of its current-year minimum capital requirement — “would be critical for these firms.”

Quarles opened the door to reducing the frequency of stress tests, however, saying that the statute’s language — which suggests that the Dodd-Frank Act Stress Test be conducted “periodically” rather than annually — “suggests the legislature wanted us to at least consider a rhythm other than annually.”

Liquidity rules, while unlikely to be rescinded entirely, would also probably change under the Fed’s proposal, with banks below $250 billion in assets subject to less intensive liquidity stress testing and risk management, Quarles said.

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