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From Banking and Finance Law Daily, February 6, 2014

Financial stability and data security take center stage for Senate Banking hearing

By Colleen M. Svelnis, J.D., and John M. Jascob, J.D.

The heads of the banking regulatory agencies testified on Feb. 6, 2014, at the Senate Banking Committee’s hearing on the oversight of financial stability and data security. Federal Reserve Board Governor Daniel K. Tarullo, Comptroller of the Currency Thomas Curry, and Federal Deposit Insurance Corporation Martin Gruenberg, provided updates on their agencies’ implementations of the Volcker Rule and other regulations mandated by the Dodd-Frank Act. The agency heads also responded to inquiries from committee members concerning the deterrent effect of recent enforcement efforts.

Federal Reserve Board. Tarullo delivered an update on Dodd-Frank implementation and described the key regulatory and supervisory priorities for 2014. He stressed that work remains to address the problems of “too big to fail” and systemic risk. Tarullo reviewed the implementation of the Dodd-Frank reforms including the proposed rule the Fed issued in October 2013 covering liquidity rules for large banking firms. He stated that liquidity rules are an important contributor to financial stability

Tarullo also talked about how stress testing has become a “key part” of the supervisory efforts for large banking firms. The Fed has recently issued proposed supervisory guidance and interim final rules in this area. Tarullo stated that the Fed is continuing to “improve the implementation of our stress testing framework by refining the formulation of the hypothetical macroeconomic scenarios that form the basis of the stress tests.”  He said that the scenarios now incorporate other adverse developments, including a decline in housing prices, the default of the largest counterparty, and a severe worsening of global economic conditions. He further commented that the scenarios must continue to evolve over time as risk characteristics and business models evolve.

The Federal Reserve has increased transparency for capital planning and stress testing, publishing a policy statement and a paper over the past six months, according to Tarullo. With regard to the Volcker Rule, Tarullo stated that success will depend upon how well the implementing agencies supervise and enforce the rule. To further this goal, the agencies have created a working group and have approved an interim final rule to permit banking entities to retain interests that would otherwise be prohibited under the Volcker Rule’s covered fund investment prohibitions. Additionally, a final rule was approved in December clarifying the derivatives “push out” provision.

Fed regulatory priorities for 2014 include:

  • establishing enhanced prudential standards for large U.S. banking firms and foreign banking firms; and

  • developing regulatory proposals that reduce the probability of failure of globally systemically important banks (GSIBs). 

OCC – Tom Curry testified on the OCC’s activities in the past year and said overall there has been improved strength in the industry. He stressed that the financial services industry is an attractive target for cyberattacks. To combat this, the OCC refines its supervisory process on an ongoing basis. Curry reviewed the OCC’s activities, including the following:

  • an independent peer review study to assess the effectiveness of OCC’s supervision of large and midsize banks;

  • recently proposed heightened expectations guidelines to strengthen the risk management and governance practices of our large banks;

  • the OCC’s expectations of the banks under supervision with regard to their ability to defend both their systems and their customers’ confidential information from cyber threats;

  • the OCC’s role in supervising the retail payment system activities of banks;

  • the OCC’s ongoing efforts to implement the Dodd-Frank Act and to strengthen bank capital, risk-based capital rules, proposed liquidity rules and enhanced leverage capital ratio requirement;

  • an overview of the finalized Volcker Rules and the agency’s progress in implementing specific provisions of Title VII of the Act; and

  • a summary of other rulemaking projects required by the Dodd-Frank Act on which the OCC has made substantial progress, including the appraisal and credit risk retention rules.

FDIC. Martin Gruenberg reviewed the Volcker Rule implementation and described the actions the agency has taken on the risk retention and qualified mortgage rules. “The challenge to the agencies in implementing the Volcker Rule was to prohibit the types of proprietary trading and investment activity that Congress intended to limit, while allowing banking organizations to provide legitimate intermediation in the capital markets,” Gruenberg stated. He says that the final rule is intended to preserve legitimate “market making and hedging activities” while maintaining “market liquidity and vibrancy.” Additionally, he gave an update on FDIC progress in implementing the authority provided to the FDIC to resolve systemically important financial institutions and proposals to improve the quantity and quality of capital. He also reviewed data integrity issues for the banking industry.

Gruenberg descried how, in August, the FDIC Board approved an NPR issued jointly with five other federal agencies to implement the credit risk retention requirement of the Dodd-Frank Act. The proposed rule generally requires that the sponsor of any asset-backed security retain an economic interest equal to at least five percent of the aggregate credit risk of the collateral.

Gruenberg stated that payment card data integrity is a concern of the federal banking agencies, even though they do not have the authority to regulate the payment card operations of retail merchants.  However, Gruenberg says the agencies can examine merchant acceptance and payment card issuing operations that occur under the direct control of a bank. Data security can disrupt bank operations and undermine confidence in the banking system and the economy. According to Gruenberg, the FDIC, in its role as supervisor of insured institutions, analyzes emerging cyberthreats, occurrences of bank security breaches, and other incidents.

Additionally, Gruenberg described how the Federal Financial Institutions Examination Council formed a Cybersecurity and Critical Infrastructure Working Group in June 2013. This working group serves as a liaison with the intelligence community, law enforcement and homeland security agencies on cybersecurity and critical infrastructure protection-related issues.

The FDIC has also issued guidance to financial institutions with respect to keeping data secure, protecting customers, and responding to breaches of data security. But Gruenberg says the FDIC’s most direct role in ensuring cyber security within the financial sector is through its on-site examination programs. The FDIC is assisting community banks with special planning and training to combat cyber security risks.

Securities and commodities regulators. Securities and Exchange Commission Chair Mary Jo White and Commodities Futures Trading Commission Acting Chair Mark Wetjen also testified at the hearing. White noted that the SEC and the CFTC have recently jointly adopted Reg. S-ID, which requires certain regulated financial institutions and creditors to adopt and implement identity theft programs.

Wetjen testified that the agency has completed most of its initial mandate under the Dodd-Frank Act, with only a few rulemakings remaining to be re-proposed or finalized in order to complete implementation of the statute.

Warren queries enforcement. Sen. Elizabeth Warren (D-Mass) questioned the effectiveness of regulatory enforcement efforts to deter crime. Warren observed that JPMorgan Chase reported spending $17 billion to settle federal enforcement actions in 2013, yet gave CEO Jamie Dimon a 75-percent salary increase based on his performance. She suggested that the public now has little confidence that financial regulators will actually impose penalties that will deter wrongdoing.

In response, Wetjen said the CFTC believes the agency’s recent enforcement actions have begun to influence the behavior of industry participants. He cited as an example the $1 billion settlement that the CFTC recently reached with banks involved in the LIBOR manipulation scandal.

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