FDIC's Hill: Pause new bank regulations amid interest rate environment

Bloomberg News

WASHINGTON — Federal Deposit Insurance Corp. Board Vice Chair Travis Hill said Thursday that regulators should pump the brakes on a host of proposed regulations until interest rates have stabilized. 

In remarks delivered to the Cato Institute Thursday, Hill said that completing a slate of ambitious new rules around capital, liquidity, living wills and other cost-intensive areas — combined with an already precarious economy and a tighter interest rate environment — could lead to unintended consequences.

"While I think that some response to the bank failures is warranted, I worry that an overreaction is underway, and that we are moving too quickly to impose a long list of new rules and expectations at a time when conditions remain precarious," Hill said. "There's a compelling case to at least try to get through the rate cycle and sort of see where we are when the dust settles, and then we can kind of take stock of what all the lessons learned are, and sort of decide which of the policy proposals are most worthwhile."

Regulators have unveiled a laundry list of new regulations including those implementing international banking standards related to capital retention and others responding to March's bank failures.

Often referred to as the Basel endgame proposal, the rules would compel banks with between $100 billion and $700 billion in total assets to use standardized risk models for market, credit and operational risk rather than allowing them to self evaluate such indicators. Firms would also need to include unrealized gains and losses on available-for-sale securities when calculating capital and lower the threshold for application of the supplementary leverage ratio and the countercyclical capital buffer from $250 billion to $100 billion in total assets. 

Hill echoed banking trade groups in asserting that regulators' recently proposed rules implementing Basel III standards were unnecessary and would incentivize banks to reduce the availability of and raise the cost of loans to consumers.

"Our capital rules for our largest banks are already meaningfully more conservative than those in other developed jurisdictions," Hill noted. "The result [of these rules] will be some combination of higher prices and less availability of products and services."

Hill had more mixed feelings about other rulemakings pending at his agency aimed at improving the likelihood of orderly resolving large banks. He said he broadly agreed with the FDIC's recent proposal to impose a long-term debt requirement on large regional banks.

"There were several aspects of the proposal that I would have addressed differently, but I still think the proposal was worth issuing to receive comments," he said. "The presence of long-term debt would be helpful regardless of how a bank is resolved."

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But he disagreed with the FDIC's recent proposal to revamp resolution reporting for banks.

"​​While resolution plans can provide the FDIC with some useful information and certain aspects of the proposed changes might be helpful, I think the proposal could have better focus on key areas of resolution planning, such as maximizing the likelihood of a weekend sale in the event of a regional bank failure," he noted. 

"Rather than make the merger process more difficult, we should instead try to address some of the underlying causes of consolidation, which includes the ever-rising cost of compliance, the steep challenges associated with technology adoption and the dramatic decline of de novo activity since the 2008 financial crisis," he said. "Additionally, the current merger application process is in many cases too long and too opaque."

Hill expressed concern about potential changes to liquidity rules for large banks, including altering the liquidity coverage ratio, or LCR — a cache of high quality liquid assets that regulators have required from banks since the 2008 crisis, and which can be sold or monetized in times of stress. Hill said the recent spate of bank failures showed that banks in trouble tend to leverage their high quality liquid assets rather than sell them outright — an aspect of the LCR that has not been sufficiently considered.

"I understand the impulse to reconsider aspects of our liquidity rules in light of lessons learned but if we do, we should do so holistically," he said. "If we're going to change outflow assumptions for uninsured deposits to reflect the possibility that they may run more quickly than previously expected, we should also consider that in such an event, banks are unlikely to fire-sale their stockpile of high quality liquid assets in a matter of hours, and instead will more likely pledge all assets available to borrow against."

He said he generally agreed with reexamining supervisory practices like monitoring interest rate risk, concentrations of uninsured deposits, liquidity risk management and contingency funding, but that ultimately it is paramount that supervisors step up their game.

"Bank supervision cannot and should not prevent all bank failures," he said. "As we consider ways to ensure timely remediation of supervisory issues, supervisors also need to consider ways to, first, complete exams and communicate findings in a more timely way, and, second, better prioritize core safety and soundness risks."

Hill also disagreed with the FDIC's focus on addressing climate related financial risk, saying he had never witnessed a climate induced bank failure. Rather, he said, climate disasters are moments of opportunity for firms.

"Never once have I ever heard a bank supervisor or FDIC staff member mention a climate event as causing stress at a particular bank, [and] there is no record of banks ever failing because of climate-related events," he said. "Banks often benefit in the aftermath as demand for loans grows, recovery funds flow into the community and economic activity rebounds."

He went on to indicate that, much like the reaction to higher capital, banks would likely react to climate risk guidance by retracting credit or charging low- and moderate-income consumers and businesses more for loans. Regulators have declared weather-related emergencies during three natural disasters so far this year. 

Hill's hypothesis that higher capital cushions at banks reduce lending is far from a settled fact, however. A 2019 review of academic literature by The Bank for International Settlements found no evidence of any negative correlation between bank capital and the growth of loans or GDP, but instead found that higher levels of capital were shown to bolster lending in times of financial crisis. 

FDIC Chairman Martin Gruenberg echoed the idea that stronger cushions of capital against losses ultimately bolster a bank's long-term ability to provide services through hard times and would only cause a modest reduction in banks' short-term profitability, since most banks already have adequate capital to meet the rules. 

"The majority of banks that would be subject to the proposed rule currently have enough capital to meet the proposed requirements," Gruenberg noted when the Basel III proposal was issued.