A Tale of Two Washingtons Awaits Wall Street Banks

WASHINGTON — Big banks are about to experience a tale of two Washingtons.

On Friday, a top Federal Reserve official said regulators were preparing to soften some rules imposed on the biggest banks after the financial crisis, including making it easier for them to pass annual tests that gauge their ability to withstand a severe economic downturn.

Randal Quarles, the Fed’s vice chairman for supervision, said the Fed wants to make rules more efficient and less burdensome for banks and said he wants to end the “public shaming” of banks that had developed around the Fed’s annual stress tests.

“What we’re doing is recalibrating in light of experience,” he said during a speech at the Brookings Institution.

Yet House Democrats are preparing to step up scrutiny of big banks when they assume power next year, in hopes of slowing the turn toward deregulation initiated during President Donald Trump’s first two years in office.

“We have oversight of the big banks,” Rep. Maxine Waters, D-Calif., who is expected to become the chairwoman of the House Financial Services Committee, said in an interview. She said she wanted to make sure “our banks are providing the services we are expecting them to provide.”

The banking industry has prospered under the postcrisis regulatory regime. The industry’s profitability during the first half of 2018 reached the highest levels since the crisis, the Fed said Friday in an annual report on its regulatory activities.

The Trump administration has argued that regulation is impeding lending, but the new Fed report said that overall loan growth “remains robust,” up by about 30 percent since 2013 despite the continued weakness of residential real estate lending.

Waters said she was more concerned about the laxity of regulation in some areas than bank lending. A vocal critic of Trump’s policies, Waters will soon be armed with subpoena power and oversight authority of financial institutions and federal regulators.

She said she would be particularly focused on the practices of Wells Fargo, which has paid billions of dollars in penalties for selling unnecessary products to consumers, fraudulently opening customer accounts and charging improper fees to mortgage and auto loan customers.

“We are concerned about Wells Fargo,” said Waters, who is planning to meet with the bank’s executives and could call them to testify at a hearing.

She said she also plans to look carefully at the efforts of Mick Mulvaney — the acting director of the Consumer Financial Protection Bureau — to weaken the bureau’s enforcement activities and at Trump’s ties to Deutsche Bank, which has faced legal trouble for laundering money for Russian entities.

“We’ll work on trying to find out more about the relationship with Deutsche Bank, with him and his family and money laundering,” Waters said, referring to Trump.

She insisted that, in exercising oversight authority, she is not engaging in retaliation for being disparaged as “low IQ” by the president.

“It has nothing to do with what he said about me,” she said. “That’s meaningless.”

Waters said she hopes to find common ground with Republicans, including on an overhaul of federal flood insurance. But her priorities, for the most part, stand in stark contrast to those of the current committee chairman, Rep. Jeb Hensarling, R-Texas, who spent the past two years pushing to water down the rules created by the 2010 Dodd-Frank law and to neuter the consumer finance watchdog set up by the Obama administration.

This year, Hensarling helped shepherd through a bill that relaxed some of those rules.

The 2010 law, for example, established stricter regulations for banks with at least $50 billion in assets. The new legislation raised the threshold to $100 billion and instructed the Fed to consider leniencies for even larger banks. Last month, the Fed complied, proposing to divide the biggest banks into four categories. Under the proposal, only a few top-tier behemoths like JPMorgan Chase and Bank of America would still be subject to the toughest rules.

Under Waters, the committee — which has oversight of the Fed as well as the banking industry — is likely to scrutinize the Fed’s plans to soften regulations.

But the Fed has considerable latitude to move ahead with those plans under existing law, and there is little prospect that House Democrats could pass legislation to strengthen regulation because the Senate and White House remain under Republican control. Quarles emphasized that the Fed is committed to the overall model of postcrisis financial regulation.

“I really don’t view the regulatory proposals that we have put forward, those that we are thinking about, those that I talked about today, as relaxation,” he said.

Instead, he emphasized that the Fed has an obligation to make regulation as efficient as possible.

One target is the Volcker Rule, which limits propriety trading. “The rule as it currently exists is too complicated,” Quarles said, echoing the concerns of the biggest banks.

He also proposed changes to the Fed’s annual “stress tests,” which assess the ability of the largest banks to survive a simulated financial crisis.

Quarles said the Fed wants to help banks meet its requirements, for example, by publishing information about the tests and inviting public comment on the risks that should be included.

H. Rodgin Cohen, a prominent Wall Street lawyer, said the Fed’s willingness to work with the industry would ultimately be beneficial for overall financial stability. “I don’t think regulatory dialogue translates into capture,” said Cohen, a senior chairman at Sullivan & Cromwell. “It really does mean ‘listen.'”

Others, however, worry the changes amount to less regulation.

Nellie Liang, a former Fed official who played a key role in creating the stress test process after the financial crisis, cautioned last year that disclosing too much information to banks could turn the tests into an ineffective “take-home exam.”

Trump has since nominated Liang to an open seat on the Fed’s board of governors, and she is awaiting a Senate confirmation hearing.

Quarles, asked about that critique Friday, offered his own metaphor. He said the Fed was proposing to give banks a textbook, not the test itself. He has previously compared the Fed’s plans to speed-limit signs.

While playing down the possibility that banks could cheat, Quarles said he was worried that increased transparency would focus banks on the Fed’s view of potential risks, rather than developing their own assessments based on the risks they are undertaking.

“There’s an almost irresistible incentive that that’s what banks will do,” he said, “and their own thinking about their internal risks will erode to some extent.”

Quarles also called for an end to the Fed’s current practice of publicly identifying banks that struggle to pass the so-called stress tests, describing it as “public shaming” and saying he would prefer to let regulators address such shortcomings privately.

Daniel Tarullo, the Fed governor who oversaw regulation during the Obama administration, also supported this change. But it could remove an incentive to conduct rigorous tests.

“Quarles is for transparency when it serves financial institutions and not when it serves the public,” said Gregg Gelzinis, a research assistant at the left-leaning Center for American Progress.

The Fed is also moving to simplify, and in some respects to weaken, the capital requirements limiting the reliance of banks on borrowed money.

The rules require banks to obtain a minimum portion of their funding from equity investors, in the form of capital. That funding provides a buffer against potential losses because it does not need to be repaid.

In April, the Fed proposed a set of changes in the calculation of capital requirements that it said would replace 24 rules with 14.

Quarles said Friday that the Fed was delaying those changes until 2020, as it seeks to address technical issues raised by banks.