9 Takeaways from the Prudential Regulators Hearing

Federal prudential banking regulators from the Federal Reserve, OCC, FDIC and NCUA appeared before the U.S. House Financial Services Committee today. The hearing, "Oversight of Prudential Regulators," examined recent rulemakings and activities, including the Basel capital proposal, novel bank charters and fraud.

Here are nine key takeaways from the hearing.

1. Federal Reserve master account access for novel institutions like crypto firms should remain strictly limited and subject to robust regulatory requirements.

Rep. Stephen Lynch (D-MA): Ms. Bowman, I've got an overriding concern about just generally the convergence of traditional banking, where we have a lot of safeguards and guardrails, and what's happening in crypto, as I'm sure you're aware. Yes, we've been experiencing a so-called crypto crash recently, and I know that I know that Kraken was, a while back, was given a Federal Reserve master account that was granted even before we had the framework set up. Are we looking at what's going on with Kraken and whether they're in full compliance given the nosedive that crypto has taken recently?

Vice Chair Miki Bowman: Thank you for that question, Congressman Lynch. The Federal Reserve has a process for approving applications, a tiered approach for approving applications for access to the payment system. Our approach for Kraken was for a limited purpose, and for a limited period of time. The Kansas City Reserve Bank approved that limited purpose application, and the 12 months will lapse early next year. We look forward to understanding how that entity will be using its access, very limited access to the payment system, to understand how other similar entities might use an account as well.

2. Non-traditional entities accessing Federal Reserve payment accounts, often termed "skinny" master accounts, must be held to equivalent BSA/AML compliance and illicit finance standards as chartered banks.

Rep. Sean Casten (D-IL): So, here's the issue. I want to get to Ms. Bowman. If you have to have a charter in order to get into a master account situation, the OCC charters don't require compliance with the CRA, don't require your parent companies to be to be subject to the Bank Holding Company Act, there are lower protections that are in there - and if you've got access to these master accounts, skinny or otherwise, you can move money through the system much more quickly. The concern would be if you've got people who can move that money that don't otherwise have the kind of AML protections that we want to have in the system. So are we confident that this process, if it's too difficult for Mr. Gould to give a yes or no, do they have the same equivalent AML that other charter banks will have? How are we protecting against making sure that people who get these skinny accounts can't use that as a way to bypass some of our AML protections?

Vice Chair Miki Bowman: Well, that's a good question. I do want to recognize that one of my colleagues, Chris Waller, is responsible for payments on the Federal Reserve Board, I do serve on the committee for payments as well. We did just issue a proposal which does require BSA/AML requirements as a part of that analysis. So it is not entirely accurate to say that there's no requirement for BSA/AML procedures. There's also not necessarily a requirement for a charter, a chartered entity, to be able to qualify for a master account, especially for one of the limited purpose ones, as we call them, skinny master accounts.

3. Future updates to the Basel capital framework must comprehensively address duplicative stress testing requirements to eliminate regulatory overlap that imposes needless costs to financial intermediation.

Rep. Mike Lawler (R-NY): I appreciate the work and leadership each of you has put into revising the original Basel III proposal. I support the revised proposal, it represents a significant improvement. The new proposal attempts to address the overlap between risk-based capital and stress tests in the treatment of market and operational risk. While I appreciate the consideration behind the agency's approach, more comprehensive amendments to include stress testing would be needed to address this overlap fully. Vice Chair Bowman, how do you plan to more finely tune the requirements to optimize the balance between capital requirements and costs?

Vice Chair Miki Bowman: Well the comment period on the Basel proposal and the other capital proposals ends on June 18th, and we look forward to reviewing all of the comments and would be happy to discuss any concerns that you have with you directly. On other issues and other matters, we have the stress testing proposal which has not yet been finalized, it will be hopefully by the end of this year, and we're optimistic that we will address the overlaps that existed between the original stress testing framework and the Basel proposals as we're completing that work.

4. Mitigating complex fraud requires expanded data sharing and cross-agency government cooperation beyond the banking agencies.

Rep. Mike Lawler (R-NY): We've seen a dramatic rise in fraud, from AI-generated impersonation scams to criminals exploiting gaps in the telecom and payments ecosystem. The reality is that fraudsters are innovating faster than the system built to stop them, and consumers and financial institutions are paying the price. Comptroller Gould, how can the government do more to help consumers and financial institutions prevent fraudsters from being successful?

Comptroller Jonathan Gould: Thank you very much for the question, Congressman. The agencies together did a RFI last year, and from that RFI I learned a number of things, including the necessity of increasing data sharing around fraud, so that more stakeholders have access to potential fraud actors. I think it was also a humbling experience - I learned that we, the OCC, are not alone, meaning we can't solve the problem on our own. This is something that transcends just the federal banking agencies and involves other aspects of the U.S. government as well, and so, as my colleague mentioned, with the FLEC, you know we also work together on financial literacy across the board. I would note here that financial literacy is at least potentially a part of the solution, and President Trump's accounts, will be very valuable in that regard, since it teaches financial literacy at a young age. I actually signed up my youngest son for it the other day, so I'm excited about that. So, again, I think this is going to require a multifaceted approach across a number of government agencies to address. I recognize there are issues around who bears the burden of some of these fraud events, including just among and within banks across the industry, and I know there's been some tension between larger banks and smaller banks, and the OCC, given the fact that we supervise many of the largest banks, has been attempting to facilitate some of those disputes.

5. Banking regulators must proactively coordinate with third-party service providers to defend the financial ecosystem against advanced, automated AI cyber vulnerabilities.

Rep. Bill Foster (D-IL): Early last month, the Treasury Department convened an emergency briefing with the CEOs of America's GSIBs and other CEOs to discuss the cybersecurity risk of Anthropic's Mythos model, which excels at finding and exploiting cyber vulnerabilities at an alarming rate. To date Anthropic claims that the model has been used to find more than 10,000 high and critical level security flaws in otherwise trusted software. Anthropic has provided early access to Mythos to large companies, including US GSIBs, so that they may scrub their software for vulnerabilities, but I worry that smaller financial institutions have not received equivalent access in a timely manner. So, what's the policy here? Who exactly received access to Mythos on what time scale? And I guess I'll just go down the line here. Vice Chair Bowman?

Vice Chair Miki Bowman: Thank you, Congressman Foster. This is a very important issue, and one that we're working together on. I can't disclose who has had access, but I can tell you that we're working both with service providers and within the banking industry to work together to understand what impacts we may need to have them mitigate and address. We have not ceased our cyber exams, in fact we continue to work with our institutions to understand how they're planning to respond.

6. The OCC's shift to a principles-based venture lending framework removes arbitrary asset classification penalties that previously restricted credit access for startup enterprises.

Rep. Ann Wagner (R-MO): Comptroller Gould, last December your agency issued updated guidance on venture lending. This guidance states that the OCC's policy does not discourage banks from engaging in venture lending, but instead places responsibilities for those decisions with bank management rather than prescriptive agency standards. Can you speak to what was wrong with the OCC's previous 2023 guidance on venture lending and why this update was necessary?

Comptroller Jonathan Gould: Yes, ma'am. Our prior guidance treated too often venture, so-called venture loans as non-pass at origination, which means that very few banks are going to make loans that are classified in that negative way at origination, which of course dried up the venture lending industry and the small businesses that depend upon them. So we rescinded that guidance, replaced it with what I would view as a more common sense approach.

7. A federal preemption framework safeguards a competitive, nationwide market that allows banks of all sizes to operate on even terms.

Rep. Andy Barr (R-KY): Comptroller Gould, the OCC's recent rulings on preemption are very important. You've said that preemption isn't a big bank versus small bank issue, that even community banks benefit because they're no longer limited by arbitrary geographies. Quickly, can you speak to how defending a uniform framework advances a competitive environment for banks?

Comptroller Jonathan Gould: Yes, sir. It allows more banks to compete with one another by creating nationwide markets in which they can compete on even terms.

8. The Federal Reserve must prioritize the standardization and operational modernization of the discount window to ensure it can serve as a rapid, reliable lender of last resort during high-speed liquidity crises.

Rep. Ritchie Torres (D-NY): On March 9th, 2023 Silicon Valley Bank had $42 billion of withdrawals in a single day, one quarter of the bank's total deposits. In a world where deposits can flee a bank at the click of a button, the Fed's slow-moving discount window can no longer keep pace with a fast-moving financial system. A Federal Reserve without an effective discount window is a little like a hospital without an effective emergency room. Imagine calling 911 and no one responding, or imagine calling 911 and indefinitely being put on hold. Seems to be the experience of the Fed's discount window. Vice Chair Bowman, the Federal Reserve has 12 reserve banks, each operating its own discount window. Do all 12 reserve banks maintain identical operating hours?

Vice Chair Miki Bowman: I'm not aware specifically, but it's up to the reserve bank to post their operating hours.

Rep. Ritchie Torres (D-NY): In the three years since the SVB collapse, has the Federal Reserve undertaken any effort to standardize discount window operations across the system?

Vice Chair Miki Bowman: I'm not aware of efforts to standardize the approach. I am aware of efforts to try to modernize the infrastructure.

Rep. Ritchie Torres (D-NY): And have those efforts succeeded?

Vice Chair Miki Bowman: I think we should probably ask the banking system.

Rep. Ritchie Torres (D-NY): My frustration is the greatest problem is not that the Fed is failing to modernize the discount window. The greatest problem, as far as I can tell, is that the Fed is not even trying. Do you have direct jurisdiction over…?

Vice Chair Miki Bowman: I do not.

Rep. Ritchie Torres (D-NY): If you did, how long would it take you to fix it?

Vice Chair Miki Bowman: I think we have had conversations internally about how long it might take us to resolve that, and we think it would be a period of months.

Rep. Ritchie Torres (D-NY): And yet it's been three years since SVB.

Vice Chair Miki Bowman: Correct.

Rep. Ritchie Torres (D-NY): So, I think the American people have a right to be frustrated by the Fed's failure to modernize and standardize the discount window. In my view in order for the Fed to be a lender of last resort, not only on paper but in practice, it must be capable of responding rapidly to emergencies and rapidly inject liquidity. Is that a fair expectation?

Vice Chair Miki Bowman: I agree.

9. The Federal Reserve's reliance on a 2019 baseline compromise for GSIB surcharge coefficients fails to account for past economic growth, risking the competitive position of U.S. banks.

Rep. Brad Sherman (D-CA): We're supposed to account for economic growth in drafting these regulations, you use scoring methodology using a base year of 2019 rather than 2015 so you're not reflecting economic growth that occurred after the regulation process began. Is there any justification to explain why the proposal does not account for economic growth from 2015 to 2019 and does that put us at a disadvantage in competing with foreign banks?

Vice Chair Miki Bowman: I appreciate that question. You're referring to the GSIB surcharge calibration?

Rep. Brad Sherman (D-CA): Exactly.

Vice Chair Miki Bowman: I'll be honest with you, the reason that we started at 2019 was because, in working with my board to understand how I could get support for moving this proposal forward, this was the compromise that we were able to strike.

Rep. Brad Sherman (D-CA): But what justifies - not. Other than saying, well, we got together and we picked it, what justifies ignoring growth between 2015 and 2019?

Vice Chair Miki Bowman: Well, we also recognize that in 2019 many of my board members stated that the level of capital in the banking system was just about right. So it was a compromise. We did discuss and review going back to 2015, but it would have lowered the capital requirements to a level that some were uncomfortable with.

Rep. Brad Sherman (D-CA): Yes, the chairman commented that the capital levels were just about right in 2019, So then you go back to 2015? I'm surprised you, the only defense you have for this rule is, well, we got together, we discussed it, and some people wanted to do it, wanted to go in one direction or other direction. I don't think there's any reason not to ignore the four years of economic growth.