Treasury Undersecretary for International Affairs Lael Brainard July 20 sought to allay a key senator's concerns that foreign regulators will fail to match the financial regulatory reforms recently passed by Congress and thus severely mitigate the effects of the legislation.
At a hearing before the Senate Banking Committee's Security and International Trade and Finance subcommittee, she assured Sen. Evan Bayh (D-Ind.) that like the United States, the major foreign financial regulators were battered by the financial crisis and are committed to reform.
Also at the hearing, Federal Reserve Board member Daniel Tarullo said international banking regulators hoped to complete new global standards for minimum bank capital levels and liquidity requirements by a November meeting of the Group of 20 leaders in Seoul, South Korea.
Tarullo said the Fed thinks "large institutions should be sufficiently capitalized so that they could sustain the losses associated with a systemic problem and remain sufficiently capitalized to continue functioning effectively as financial intermediaries." He noted, however, that meeting that standard "will require a considerable strengthening of existing requirements" regarding both the amount and "quality" of capital held by such institutions.
Common Objectives Seen Internationally.
Meanwhile, responding to questions from Bayh, chairman of the Banking subcommittee, Treasury's Brainard noted that all of the major foreign financial jurisdictions "have come through the common crucible of the crisis" that came to a head in fall 2008. As such, she said, the Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173) articulates "a common set of objectives; that is clear from the discussions we've had at the highest political levels" with foreign counterparts.
To bolster her claim, Brainard cited discussions among the G20 countries regarding capital standards for banks. "That's pretty unusual and I think shows the level of commitment," she said.
Brainard continued that "the international architecture we are developing should go some distance in advancing our convergence agenda." She cited the Financial Stability Board and International Monetary Fund as two organizations that could, through peer pressure and peer review, help enforce standards on the international community.
Still, Bayh was not swayed completely. "If peer review is the best we can do--peer pressure and threat to reputational risk--I guess it's better than nothing. I'm all in favor of peer review, but if we can put a little teeth behind [it], that would be even better." He also cited the IMF as an organization with good intentions, but limited clout.
Amplifying, Bayh raised the issue of Greece's currency and debt crisis and the European Union reaction to it. "We have an example here where we have common principles and common ideals, but when it came to tough decision-making and enforcement in ways that would really make a difference, [convergence] didn't happen," Bayh said.
The senator also betrayed lingering doubt about the international discussions on capital standards. "I'm delighted they're talking about the capital standards, but are they going to be willing to follow through on their statements?" he asked.
Meanwhile, Tarullo said capital standards are "among the most important things" international regulators need to impose, and also are "among the things most susceptible to effective convergence around the world."
Bayh agreed, saying "some of us will look at [the international community's] willingness to adopt meaningful capital standards, even if they pinch domestically a little bit." In that vein, he also raised the issue of "stress tests" for banks in foreign jurisdictions--and concerns about their transparency--as indicators of global regulators' sincerity in converging with U.S. standards.
Tarullo also said international bank supervisors "continued to make progress" on the twin goals of developing capital and liquidity standards for banks at a Basel Committee hearing several days ago. Regarding this country's overarching goals for the standards, he said it was "particularly important" that risk weightings associated with traded instruments "be substantially increased." He added that as to the quality of the reserves, common equity was "by far the best measure of a firm's loss absorption capacity."
Need for Flexibility.
At the same time, however, Tarullo stressed that while "robust [and] common" standards are critical, it is neither "practical nor desirable" for all financial regulations to be set at a common international level. "Within a common set of agreed-upon global standards, each jurisdiction will want to tailor some of its rules and supervisory practice to national conditions and preferences."
"It is important that the United States preserve the flexibility to adopt prudential regulations that work best" in the U.S. financial and legal realms, Tarullo continued. Echoing Tarullo, Brainard said that while convergence will be critical in areas such as capital standards and oversight of swaps, "international efforts in other areas may be equally well served by coordinating different approaches across nations."
Indeed, another witness, Securities and Exchange Commissioner Kathleen Casey, the commission's point person for international affairs, said "it is critical that regulatory bodies" such as the SEC " have control over their own agendas." She cited two ongoing international initiatives--convergence of accounting standards and equity market structure--as areas in which "regulators and standard setters must bear in mind the international repercussions of their work, but ultimately must make decisions that comply with the demands of their unique mandates."
Meanwhile, under questioning from Sen. Mark Warner (D-Va.), Tarullo said there was a "reasonable prospect" that international negotiators working through the Basel Committee could complete an agreement regarding leverage ratios. He predicted that the most likely scenario was that such a standard at first would be written as a Pillar II "supervisory" requirement that would evolve into a Pillar I requirement.
For her part, Brainard said G20 negotiators have decided that a risk-based capital framework would be supplemented by a leverage ratio. She referred to such a ratio as "a supplementary backstop," but echoing Tarullo, said "it may take some time" for such a ratio to become mandatory.
Sen. Bob Corker (R-Tenn.), meanwhile, related concerns that the newly passed Dodd-Frank Act would lead to a flow of capital from the United States to countries with laxer standards. He said an expert he spoke with recently told him that foreign state representatives, particularly in Asia, were "rubbing their hands and licking their chops" because of "tremendous opportunities within their countries for an out-migration of jobs from our country" because of the bill.
Responding to a question from Corker, Tarullo said foreign regulators' greatest concerns about H.R. 4173 are the measure's Volcker Rule, which restricts banks' speculative activity, and the so-called push-out provision, which limits banks' ability to make markets for derivatives.