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Systemic Risk Council Letter to Federal Reserve About Supervision of Foreign Banking

Systemic Risk Council

April 5, 2013

Dear Chairman Bernanke:

The Systemic Risk Council is writing in support of the Federal Reserve’s proposed rule regarding the supervision of foreign banking and nonbank financial operations (FBOs) in the United States.  This proposed rule would implement the enhanced prudential standards and early remediation requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) as they apply to FBOs.  The rulemaking addresses one of our key priorities: immediate action to propose and finalize rules that will substantially strengthen both the quality and amount of capital at the largest financial institutions operating in the United States, in this case, foreign financial institutions.

In the years leading up to the financial crisis, FBOs increased their reliance on short-term, wholesale funding to support long-term assets and were even more highly leveraged than their U.S. counterparts.  During the crisis and its aftermath, the Federal Reserve found it necessary to provide substantial funding to FBOs as part of its broader efforts to stabilize the U.S. financial system.  As FBOs have become major players in the United States — for example, five of the top 10 broker-dealers have non-U.S. parents — they have come to pose the same type of potential risks to the U.S. system as do large, domestically-based financial institutions.

Read more below:

Regulators Let Big Banks Look Safer Than They Are

Publication: Wall Street Journal

Author: Sheila Bair

4/01/2013 —The recent Senate report on the J.P. Morgan Chase “London Whale” trading debacle revealed emails, telephone conversations and other evidence of how Chase managers manipulated their internal risk models to boost the bank’s regulatory capital ratios. Risk models are common and certainly not illegal. Nevertheless, their use in bolstering a bank’s capital ratios can give the public a false sense of security about the stability of the nation’s largest financial institutions.

Capital ratios (also called capital adequacy ratios) reflect the percentage of a bank’s assets that are funded with equity and are a key barometer of the institution’s financial strength—they measure the bank’s ability to absorb losses and still remain solvent. This should be a simple measure, but it isn’t. That’s because regulators allow banks to use a process called “risk weighting,” which allows them to raise their capital ratios by characterizing the assets they hold as “low risk.”

Read the full editorial, Regulators Let Big Banks Look Safer Than They Are, on the Wall Street Journal website.

Alice M. Rivlin Joins Systemic Risk Council

Today, Systemic Risk Council (SRC) chair Sheila Bair welcomed Alice M. Rivlin as the newest member of the Council:

“Alice Rivlin is a leading voice on financial policy, with a breadth of experience which is second to none. I am pleased and honored that she has agreed to join the SRC,” Bair stated.

Alice Rivlin served as the Vice-Chairman of the Federal Reserve, director of the Office of Management and Budget and was the first director of the Congressional Budget Office. She is currently a senior fellow with the Brookings Institution and a visiting professor at Georgetown Public Policy Institute.

Self-funding of regulators would help fiscal mess

Publication: Politico

Author: Brooksley Born and William Donaldson

3/10/2013 —Washington has been abuzz with the automatic, across-the-board spending cuts taking effect, known as the sequester. While many have been focused on the impact on education, law enforcement and transportation safety, another important area that deserves attention is the impact on our financial market regulators: the Securities and Exchange Commission and the Commodity Futures Trading Commission. It is both wrong and dangerous to impose funding cuts on these agencies. They are already underfunded in light of their enormous new responsibilities under the Dodd-Frank Act.

The Systemic Risk Council believes that the SEC and CFTC need a robust — and dependable — source of funding. Unlike every other financial regulatory agency, the SEC and CFTC must rely on Congress for their annual funding. Other federal financial regulators (including the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and even the new Consumer Financial Protection Bureau) do not have to rely on an unpredictable congressional appropriations process for their budgets. Other regulators assess fees on industry and use those fees to fund their activities as is appropriate. Taxpayers should not have to pay for the costs of regulation.

Read the full article, Self-funding of regulators would help fiscal mess, on the Politico website.

Systemic Risk Council Letter to SEC About Internal Risk Models

Dear Commission:

While we commend the Securities and Exchange Commission for raising the minimum capital required for the very largest broker-dealers that use the alternative net capital requirements, we remain concerned that the Commission (and other federal financial regulators) continues to allow large, complex financial institutions to use their own internal risk models to set their minimum regulatory capital. As the Systemic Risk Council recently noted:

“While we commend the financial agencies for seeking public comment on important rules that raise the overall level of capital required for large, complex financial institutions, we have strong concerns about regulators’ continued willingness to allow these giant institutions to use their own internal risk models to lower their minimum required regulatory capital.

Not only do models routinely fail in a crisis (precisely when we need loss absorbing shareholder equity most) – their use for regulatory capital purposes can create perverse incentives for risk management and real competitive advantages for larger firms relative to smaller firms doing the same activity.

Minimum risk-based capital requirements should be just that: a minimum. If internal models identify additional risks that require higher capital, firms should be required to raise more equity. Management, boards, examiners, investors and counterparties deserve an objective and clear minimum risk-based capital baseline.”

Read more below:

Systemic Risk Council Letter to SEC 1-24-13

Systemic Risk Council Letter to Bank Regulators About Delayed and Weakened Global Capital and Liquidity Standards

Systemic Risk Council

January 23, 2013

Dear Chairman Bernanke, Chairman Gruenberg and Comptroller Curry:

The Systemic Risk Council (SRC) is concerned by the recent decisions to weaken and delay global capital and liquidity standards under the Basel III accords.

As you know, risk-absorbing capital, particularly when combined with stable liquidity, plays an essential role in protecting the financial system from inevitable shocks and substantially reduces the likelihood that these shocks turn into financial crises. Excessive leverage, combined with an over-reliance on unstable, short term funding were leading causes of the near collapse of our financial system in 2008.

While we recognize the need for regulators to make minor adjustments to timetables, it is essential to have higher capital standards in place as soon as possible, and to avoid any further weakening of the liquidity standards. The SRC continues to call on financial regulators to prioritize implementing Basel III for the large, internationally active banks, while at the same time strengthening the Basel III leverage ratio by raising it to 8 percent.

Read more below:

Systemic Risk Council Letter on Bank Capital 1-23-13

 

 

Systemic Risk Council Supports the FSOC’s Efforts to Reform Money Market Funds

Systemic Risk Council

January 18, 2013

Dear Financial Stability Oversight Council:

The Systemic Risk Council (SRC) is writing to commend and support the FSOC for seeking public comment on proposals to reform money market funds. It has been more than four years of study since taxpayers were forced to guarantee money market funds and the structural risks remain. We believe strong reform – namely strong capital or a floating NAV – is essential to protecting the financial markets from the systemic risks posed by money market funds. Never again should policymakers be forced to choose between a financial meltdown or a taxpayer bailout of money market funds.

The Systemic Risk Council Supports the FSOC’s Efforts to Reform Money Market Funds. As we have previously noted, the SRC believes prompt and decisive action is needed to curb systemic risks posed by money market mutual funds. When the Reserve Primary Fund “broke the buck” in 2008, extraordinary actions were required to back-stop and calm investors in money market funds and protect the short-term lending markets. The risk that emergency government support may again be needed to stem destabilizing runs from money market funds remains a serious challenge for policymakers. The SRC applauds former SEC Chairman Mary Schapiro, FSOC Chairman and Treasury Secretary Timothy Geithner, and members of the FSOC for their vigilance on this issue and we support strong capital or floating NAV as appropriate policy responses.

Read more below:

Systemic Risk Council Letter on Money Market Funds 1-18-13

 

Global Financial Markets Need to Coordinate Now or Pay the Price Later

Publication: Yahoo! Finance

Author: John Rogers

12/20/2012 —I watched the movie “Contagion” on a recent flight to Asia. It tends to dampen the enthusiasm for culinary adventures.

In reality, it’s a lot more likely that our next global contagion will come from financial markets, and not from some butcher shop in Asia. Everything we know about financial systems points to continued globalization and interdependence. With that comes the near certainty that a systemic crisis in one major market will cause severe consequences in other markets. Financial crises truly are ill winds that blow no good. As a counterbalance, the need for coordination among regulators, legislators, and others responsible for financial stability has never been higher.

The Process Has Already Begun

As a member of the U.S. Systemic Risk Council, I urge a renewed commitment to international coordination on key issues of systemic financial risk. As financial markets struggle to rebuild, it has become all too clear that no one can safely go it alone. Domestic politics and agendas often distract us from the importance of working across borders to build better markets. It is all too easy to “take a pass” on the difficult decisions and compromises required to build international agreements. Waiting until markets unravel or banks fail to take action is a costly mortgage on
future investors and taxpayers.

Read the full article, Global Financial Markets Need to Coordinate Now or Pay the Price Later, on the Yahoo! Finance website.

Prompt, Full Funding Of The SEC And CFTC Is Essential To Reducing Systemic Risk

Contact: Jeremy Ratner, jratner@pewtrusts.org, (202)540-6507

Washington , D.C. – 12/07/2012 – The Systemic Risk Council1 expressed concern that one of the clearest and most important systemic fixes needed for markets is stuck in political gridlock. SRC Chairman Sheila Bair called for prompt resolution of the funding issues related to market regulators, especially the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC):

“Congressional leadership has extended the temporary funding of government operations through March 2013 at levels that are barely higher than in 2011. This would result in a risky reduction of resources for the nation’s two primary defenders of honest and transparent markets.

“To provide just one dramatic example: the SEC and CFTC have been given critical new responsibilities under the Dodd-Frank Act for regulating the enormous and previously unregulated over-the-counter derivatives market, which has been estimated to exceed $300 trillion in notional amount in the United States and about $650 trillion worldwide.  They cannot carry out these responsibilities without substantial increases in funding. Freezing these agencies’ budgets, even temporarily, effectively hamstrings them and hinders their ability to reduce systemic risks which threaten the stability of the financial system and the economy.  We call on Congress to act promptly to provide the SEC and the CFTC with the increases in funding needed to police Wall Street and protect the financial system.

“We also believe that steps should be taken to establish adequate and ongoing funding for the SEC and the CFTC outside of the appropriations process.  Unlike most financial regulatory agencies which are funded independently through fees assessed on the industries which they regulate, the SEC and CFTC must rely on the Congressional appropriations process for their funding. This means that each year they must go to the appropriators of the House and Senate to seek approval for money to continue to operate.  Regrettably, they have had to repeatedly fight for adequate funding, as industry lobbyists have found that one way to block or slow financial reform is through convincing appropriators to restrict how much money these agencies receive—and even how they can use their funding.

“Certainly, the SEC and CFTC should be accountable to Congress in discharging their statutory missions. The Senate Banking Committee, the House Financial Services Committee, and the Senate and House Agriculture Committees must provide oversight of the agencies’ effectiveness in carrying out the mandates in their authorizing statutes.  As with any organizational entity, be it a business or government agency, to maximize effectiveness, it is essential that these agencies have certainty and continuity in their budget planning.  Their effectiveness will be impaired if their senior staff and chairmen have to engage in constant battles with the industry over adequate funding, while juggling resources and making contingency plans in the event of budget shortfalls.”

We recognize that significant budget challenges must be addressed in order to improve our  unsustainable fiscal situation, but cutting these agencies will not assist in that effort.   At most financial regulators, including at the SEC, financial regulation is paid for by fees – not by the taxpayer.  Extending that authority to the CFTC, and enabling both agencies to be fully self-funded, would lower taxpayer costs and deficit spending and dramatically improve our financial markets.

“If we want to ensure reduction of systemic risk through vigorous supervision of securities and derivatives markets, both regulators need to have a process in place that gives them confidence that they will have adequate funds to discharge their enormous responsibilities over the long term.”

The Systemic Risk Council2

Chair: Sheila Bair, The Pew Charitable Trusts, Former FDIC Chair

Senior Advisor: Paul Volcker, Former Federal Reserve Chair

Members
Brooksley Born, Former U.S. Commodity Futures Trading Commission Chair
Bill Bradley, Former U.S. Senator (D-NJ)
William Donaldson, Former U.S. SEC Chair
Harvey Goldschmid, Columbia Law School, Former U.S. SEC Commissioner
Jeremy Grantham, Co-founder & Chief Investment Strategist, Grantham Mayo Van Otterloo (GMO)
Chuck Hagel, Distinguished Professor, Georgetown University, Former U.S. Senator (R-NE)
Richard Herring, The Wharton School, University of Pennsylvania
Simon Johnson, Massachusetts Institute of Technology Sloan School of Management
Hugh F. Johnston, Exec. VP & CFO, PepsiCo
Ira Millstein, Chair, Columbia Law School, Center for Global Markets and Corporate Ownership
Maureen O’Hara, Cornell University Johnson School of Management
Paul O’Neill, CEO, Alcoa, Former U.S. Treasury Secretary
John Rogers, CFA, President and CEO, CFA Institute
Alan Simpson, Former U.S. Senator (R-Wy)
Chester Spatt, Tepper School of Business, Carnegie Mellon University, former U.S. SEC Chief Economist

 1The independent, non-partisan Systemic Risk Council was formed by the CFA Institute and the Pew Charitable Trusts to monitor and encourage regulatory reform of U.S. capital markets focused on systemic risk. The statements, documents and recommendations of the private sector, volunteer Council do not necessarily represent the views of the supporting organizations.

The Council works collaboratively to seek agreement on all recommendations. This report fairly reflects the consensus views of the Council, but does not bind individual members.

2Affiliations are for identification purposes only. SRC members participated as individuals; the statement reflects their own views and not those of organizations with which they are affiliated.”

Systemic Risk Council Letter on “Independent Agency Regulatory Analysis Act of 2012”

Systemic Risk Council

November 19, 2012

Dear Chairman Lieberman and Ranking Member Collins:

We are writing to thank the Committee for deciding to delay the markup of S. 3468, the “Independent Agency Regulatory Analysis Act of 2012” to allow more time to vet this proposal.   We have strong concerns about this legislation, particularly its impact on agency independence and effectiveness, and we commend you for withholding it.

While we share the goals of the bill’s sponsors of bringing even greater quality and accountability to the rulemaking process, we believe subjecting independent agency rules to broad executive agency review and assessment would fundamentally change the role of independent agencies and have significant negative unintended consequences.  Any modest improvements in individual agency processes that might be achieved through this significant change would be greatly outweighed by the public costs that flow from even slower agency action, the significant potential for abuse and a substantially more politicized rulemaking process.