4/19/2018 Quarles: Fed would recalibrate eSLR if Crapo bill passes - Risk.

net

Quarles: Fed would recalibrate

eSLR if Crapo bill passes
Senate or House changes to CCAR could also affect Fed’s
new stress capital buffer

Randal Quarles: “If that provision of the Senate bill were to become law, I think we would have
to consider how to calibrate our proposal”

CNP/SIPA USA/PA Images

Joanna Wright
18 Apr 2018

The Federal Reserve’s top supervisor, Randal Quarles, told a hearing in the
House of Representatives on April 17 that the Fed would have to revisit its plan
to recalibrate the enhanced supplementary leverage ratio for the largest banks if
changes to the eSLR in a draft Senate bill also become law.

“If that provision of the Senate bill were to become law, I think we would have to
consider how to calibrate our proposal to take account of the fact that certain
banks would have had a denominator of the eSLR changed for them. That
would be appropriate if it does become law,” Quarles said in his first testimony

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4/19/2018 Quarles: Fed would recalibrate eSLR if Crapo bill passes - Risk.net

as the Fed’s vice-chair for supervision before the House’s financial services
committee.

The Fed and the Office of the Comptroller of the Currency (OCC) last week
released a recalibrated eSLR for public comment. As reported by Risk.net in
January, the highly anticipated proposal scraps the static 2% leverage buffer for
global systemically important banks and replaces it with one equal to half of an
individual bank’s G-Sib capital surcharge.

In March, the Senate passed the Economic Growth, Regulatory Relief and
Consumer Protection Act (S2155), known as the Crapo bill after one of its
sponsors, Senate banking committee chair Mike Crapo. Section 402 of the
Crapo bill offers a carve-out in the eSLR for the client assets of banks whose
business is primarily custodial. The bill is now under discussion in the House.

On April 17, lawmakers were quick to press Quarles on whether he thought the
Crapo bill renders the Fed’s eSLR recalibration unnecessary, or whether the two
could co-exist. Quarles replied that he believed they could co-exist: “Both our
objective and the objective of [the Senate] provision are to adjust the eSLR so it
is not a primary binding measure.” 

Several sources told Risk.net in January that the Fed was keen to release its
eSLR proposal to head off the Senate bill. Prudential regulators are historically
reluctant to allow for carve-outs for specific assets or business models in what
they say should be a risk-insensitive backstop to risk-based capital rules.

…the time to have made this fix, to ward off

those changes, would have been several months if
not years ago
Randy Benjenk, Covington & Burling

But Randy Benjenk, a lawyer in Covington & Burling’s financial services group,

says the agencies’ attempt to front-run the Crapo bill now looks too little, too
late.  

“One way to interpret the Fed and OCC issuing this proposal is they may have
had a feeling the proposal might ward off the need for the custody bank leverage
ratio provisions in the Senate banking bill, but the time to have made this fix, to

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ward off those changes, would have been several months if not years ago,” he
says.

On the other hand, Benjenk does not expect the agencies to back down with
their changes just because of the exception for custodial institutions contained in
the Senate bill. As a result, both changes to the leverage ratio are likely to be
introduced together. 

This could be particularly unwelcome for the largest diversified G-Sibs that offer
custodial services, because they will face a double disadvantage compared with
the pure-custodian G-Sibs – namely, BNY Mellon and State Street.

Research by Risk Quantum has found BNY Mellon and State Street would
benefit primarily from the eSLR revisions. These two are also the G-Sibs that
would benefit from the Crapo bill custodial exemption.

By contrast, Citi and JP Morgan – which have large custody businesses, but are
not primarily custodians – have argued the Crapo bill should allow them carve-
outs too. They are also likely to see a much smaller reduction in their eSLR from
the Fed revisions. JP Morgan has specifically criticised linking the eSLR to the
G-Sib buffer, which it views as too heavily reliant on size metrics rather than
other systemic indicators.

Where is the Crapo bill?

However, the fate of section 402 has become uncertain, owing to delays to the
Crapo bill in the House of Representatives. S2155 was designed to garner as
much bipartisan support as possible to pass easily. It is therefore aimed chiefly
at easing the regulatory burden for regional and community banks.

A source at one of the pure-play custodian banks says they are anxious to see
the bill pass quickly, because assisting G-Sibs could prove less politically
appealing than the measures aimed at regional banks. The more the Crapo bill
passes back and forth between House and Senate, the greater the chance of
section 402 being dropped.

The bill passed the Senate in March with the support of 17 Democrats. However,
House financial services committee chair Jeb Hensarling then said he wanted to
negotiate with the Senate to add some 30 bipartisan House bills before he
would agree to add his seal of approval.

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Republican Hensarling attempted his own legislative overhaul of the Dodd-Frank

Act, which he dubbed the Choice Act. But the Senate did not take up this bill
and Hensarling has announced he will not stand for re-election in November.
Amending the Crapo bill may therefore be his last opportunity to incorporate
elements of the stalled Choice Act.

“Everyone assumes Hensarling legitimately thinks there are reform measures

that would be supported by some part of the Democratic caucus. And why
shouldn’t those bills also make part of what eventually becomes law? So it
remains to be seen how much longer he will push for some of those House bills
to be part of the legislation, and if there is maybe a more modest package of
those bills – a handful rather than dozens – how Senate Democrats who voted
for the Crapo bill might react to that,” says Benjenk.

However, a former Senate staffer tells Risk.net the White House, which has won
few legislative victories, is eager for a signing ceremony and will pressure
Hensarling to expedite the Crapo bill. A banking trade association also urged
him earlier this month to pass the bill.

Quarles is due for a second grilling by lawmakers this week: he testifies before
the Senate banking committee on Thursday.

Stress tests under stress

In addition to its impact on the leverage ratio, the Crapo bill could be a
source of more complication for another piece of new Federal Reserve
rule-making: its proposed stress capital regime.

This proposal, published on April 10, would replace the 2.5% static
capital conservation buffer with a stress capital buffer equivalent to a
bank’s worst-case losses in the Fed’s Comprehensive Capital Analysis
and Review.

However, the Crapo bill proposes raising the threshold for banks to be
subject to CCAR from $50 billion in assets to $250 billion. And some of
the amendments Jeb Hensarling, the House of Representatives’ financial
services committee chair, is hoping to make could also be significant.

“There could be plenty of changes in either the Senate or the House bills,
but either way, they are looking to change the frequency, the number of
scenarios that banks are required to run and maybe the asset-size

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threshold of who has to be subject to supervisory stress tests. With all of

these moving pieces, the Fed has put out a proposal that may be
anchored to a moving target… I look at the concept of the stress capital
buffer and I think it makes a lot of sense, unless you start taking away the
underlying stress test on which it is based,” says Ed Young, a senior
director on the stress-testing and capital planning team at Moody’s
Analytics.

Adding CCAR results to capital buffers would remove the need for
quantitative objections – the Fed’s practice of restricting capital
distributions if a firm’s capital levels fall below the minimum required ratios
in the CCAR severely adverse scenario. However, the Fed intends to
keep its ability to fail banks on qualitative grounds if there are deficiencies
in their capital-planning and risk-measurement process.

But, among the 30 or so bills that Hensarling wants to add to the Crapo
bill – according to a list circulated by his office – is HR 4293, the Stress
Test Improvement Act. It would reform CCAR, but focuses on placing a
limitation on qualitative planning objections instead.

If the two measures are combined, the Fed could end up with a very
limited range of supervisory tools related to CCAR.

“There are open questions and moving pieces related to the

Congressional bills that make it difficult to assess the impact of the Fed’s
revised capital rules, since the proposal is anchored to items that may be
changed with the open legislation,” says Young.

Editing by Philip Alexander

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