WASHINGTON — Federal Reserve Board Chair Janet Yellen on Wednesday defended policies related to commercial banks in the face of GOP criticism while also pinpointing areas where the Fed is open to regulatory easing.

In the home stretch of her term, which expires in February, Yellen for the first time sounded open to changes in the "supplementary leverage ratio," took issue with claims that the Fed's paying banks interest on excess reserves had constrained lending, and touted the central bank's efforts to reduce community banks' regulatory burden.

Yellen said paying banks interest on excess reserves — known as IOER — was an essential tool.

Federal Reserve chairman Janet Yellen
On Treasury's recommendations for regulatory changes, Fed Chair Janet Yellen said, “There are many very useful and productive suggestions that mirror things that we have been thinking and doing ourselves." Bloomberg News

"We are reliant on IOER as our key tool for setting the Federal Funds Rate, so that is a key instrument of monetary policy,” Yellen said at a hearing of the House Financial Services Committee, her first of two Capitol Hill appearances this week.

Yellen also reiterated the Fed's support for changes to the Volcker Rule to ease the trading restrictions' impact on smaller banks. On her own job prospects, she repeated her intention to serve out her term, but demurred on the question of whether she will be reappointed.

"It hasn't come up" with President Trump, she said.

Here are some key takeaways from her Capitol Hill visit.

Leverage ratio

Yellen said for the first time that she may be willing to revisit the supplementary leverage ratio — a key measure of capital strength — to make it less of a binding constraint for some of the largest banks to which it applies.

Banks have been arguing for some time that the leverage ratio — which requires banks to hold a certain amount of capital against all assets, no matter what they are — has unintended consequences and penalizes them for complying with other requirements of the Dodd-Frank Act.

More recently, the Treasury Department and Yellen’s colleague, Fed Gov. Jerome Powell, have suggested that some manner of relief may be under consideration. Yellen suggested she favors such a move.

“A leverage ratio was meant to be a backup supervisory device calibrated appropriately relative to risk-based capital requirements,” Yellen said, responding to a question from Rep. Bill Foster, D-Ill. “While in general I think risk-based capital requirements, especially for the largest and most systemic institutions, are at levels that I think are appropriate and am comfortable with, it may be that the supplementary leverage ratio needs to be recalibrated relative to that. I am very much aware of the problems you’re mentioning and considering how to address them.”

IOER

The hearing was another opportunity for GOP lawmakers to criticize the Fed's excess reserves policy. They say the interest paid to banks amounts to a subsidy, and provides an incentive for financial institutions to constrain credit.

“The Federal Reserve, by paying interest on excess reserves, is effectively paying banks not to lend," said Rep. Andy Barr, R-Ky., the subcommittee chairman on monetary policy and trade.

Barr said banks are getting a free ride and are not passing along the interest payments they receive in the form of higher yields paid to customers on their deposits.

“It doesn’t appear that any of this pass-through is happening to customer accounts, and might that compel the Fed to reconsider the merits of this IOER policy?" Barr said. "Wouldn’t it be better for growth if banks were encouraged to deploy more capital in the real economy instead of parking it at the Fed in exchange for IOER?"

But Yellen objected to that premise, and said slow loan growth was related to other factors.

“I don’t see banks as parking it at the Fed and not lending," she said. "My discussions with bankers and the information that we regularly collect suggests that banks are looking to make loans. There was a period of ... very slow loan growth … but our survey suggests that was more of a matter of demand than supply."

Yellen said it may only be a matter of time before deposit yields increase as monetary policy begins to normalize and rates rise.

“My impression is that on larger deposits or CDs, we are beginning to see some upward movement in rates that are available to customers but not on retail deposit accounts," she said. "My expectation is that … as … short-term interest rates rise that competition among banking organizations will put some upward pressure on those rates."

Regulatory relief

Yellen reiterated the Fed's support for reducing the regulatory burdens on community banks. She said certain recommendations and goals outlined in the Treasury Department’s report on changing the regulatory framework are in line with the Fed's priorities, particularly with regard to small banks and relieving them from Volcker Rule compliance.

“There are many very useful and productive suggestions that mirror things that we have been thinking and doing ourselves, with respect to tailoring of our regulations, reducing burdens on community banks,” Yellen said. “I think the recommendations pertaining to the Volcker Rule, and looking for ways to reduce burdens, are all very useful. There are a few points where we have a different view, but there’s a lot in it that is very useful.”

Rep. Blaine Luetkemeyer, R-Mo., asked that the Fed “take a more measured approach and withhold new regulation until the Fed's vice chair of supervision can be confirmed by the Senate.”

The Trump administration has nominated former Treasury official Randal Quarles to the post, which is seen as central to setting Fed bank regulatory policy.

“We have a relatively light regulatory agenda at this point. We are pleased to see a nomination," Yellen said. "Clearly we will look very carefully at the whole set of issues around regulatory burden and look forward to having the input from that individual who is confirmed."

Future Fed leadership

Yellen's testimony came as speculation has begun to intensify over who the administration plans to nominate for Fed chair when her term is up. Politico reported Tuesday that Gary Cohn, director of the White House's National Economic Council, had emerged as a potential contender. Former Fed Gov. Kevin Warsh has also been floated as a candidate. Yet in April, President Trump appeared to praise Yellen.

“I absolutely intend to serve out my term," Yellen said Wednesday. On whether she would serve another term, if asked, Yellen said, "I am very focused on trying to achieve our ... objectives and, if that happens … I would have to give it further thought."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.